Trading Analysis Combine Fundamental And Technical Analysis

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Blending Technical and Fundamental Analysis

People often ask if technical analysis can be used as an effective substitute for fundamental analysis. Although there is no definitive answer whether technical analysis can be used as a whole substitution for fundamental analysis, there is little doubt that combining the strengths of both strategies can help investors better understand the markets and gauge the direction in which their investments might be headed. In this article, we’ll look at the pros and cons of technical analysis and the factors that investors should consider when incorporating both strategies into one market outlook.

The Best of Both Worlds

Some technical analysis methods combine well with fundamental analysis to provide additional information to investors. These include:

1) Volume Trends: When an analyst or an investor is researching a stock, it’s good to know what other investors think about it. After all, they might have some additional insight into the company or they might be creating a trend.

One of the most popular methods for gauging market sentiment is to take a look at the recently traded volume. Large spikes suggest that the stock has garnered much attention from the trading community and that the shares are under either accumulation or distribution.

Volume indicators are popular tools among traders because they can help confirm whether other investors agree with your perspective on a security. Traders generally watch for the volume to increase as an identified trend gains momentum. A sudden decrease in volume can suggest that traders are losing interest and that a reversal may be on its way. (See also: Gauging The Market’s Psychological State.)

Intraday charting is growing in popularity because it enables traders to watch for spikes in volume, which often correspond with block trades and can be extremely helpful in deciphering exactly when large institutions are trading. (See also: Volume Oscillator Confirms Price Movements and The Pros And Cons Of Institutional Ownership.)

2) Tracking Short-Term Movements: While many fundamental investors tend to focus on the long haul, the odds are that they still want to obtain a favorable buy-in price and/or a favorable selling price upon liquidating a position. Technical analysis can be handy in these situations as well.

More specifically, when a stock punches through its 15- or 21-day moving average (either to the upside or the downside), it usually continues along that trend for a short period of time. In other words, it is largely an indicator of what to expect in the coming term. Incidentally, 50- and 200-day moving averages are often used by chartists and some fundamental investors to determine longer term breakout patterns. (See also: Moving Averages.)

For those looking to time a trade or to solidify a favorable entry or exit price in a given stock, these types of charts and analyses are invaluable.

3) Tracking Reactions Over Time: Many fundamental analysts will look at a chart of a specific stock, industry, index or market to determine how that entity has performed over time when certain types of news (such as positive earnings or economic data) has been released.

Patterns have a tendency to repeat themselves, and the investors who were lured (or put off by) the news in question tend to react in a similar manner over time.

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For example, if you take a look at the charts of various housing stocks, you’ll often see that they react negatively when the Federal Reserve chooses to forgo a cut in interest rates. Or check out how home improvement stores tend to react when reports of new and existing home sales decline. The reactive move lower is pretty consistent each time.

In short, by analyzing historical trends, investors can ballpark the possible reaction to a future event. (See also: Why Do Stock Prices Change following News Reports?)

The Downside to Blending

Technical analysis may also provide an inaccurate or incomplete perspective on a stock because:

1) It’s History: While it is possible to decipher and anticipate certain movements based on patterns or when a particular stock crosses a major moving average, charts cannot usually predict future positive or negative fundamental data—instead they are heavily focused on the past.

However, if news leaks out that a company is about to release a good quarter (for example), investors might be able to take advantage of it and this good news will be apparent in the chart. A simple chart cannot provide the investor with crucial long-term fundamental information such as the future direction of cash flow or earnings per share.

2) The Crowd is Sometimes Wrong: As mentioned above, it’s nice to buy into a stock that has upside momentum. However, it is important to note and understand that the crowd is sometimes wrong. In other words, it is possible that a stock that’s being accumulated en masse this week may be under heavy distribution the next. Conversely, stocks that are being heavily sold this week may be under accumulation in the weeks to come.

A terrific example of the “crowd is wrong” mentality can be found in the large amount of money that went into technology shares at the turn of the millennium. In fact, money kept flowing into shares of companies such as CMGI or JDS Uniphase, as well as a number of other high-tech issues. When the bottom dropped out, the money flow into these stocks and the stock markets on which they traded dried up almost overnight. The charts did not indicate that such a harsh correction was coming. (See also: The Madness of Crowds.)

3) Charts Don’t Typically or Consistently Forecast Macro Trends: Charts also are generally unable to accurately forecast macroeconomic trends. For example, it is nearly impossible to look at a major player in the oil and gas sector and decipher definitively whether OPEC intends to increase the amount of oil it pumps, or whether a fire that just started at a shipping facility in Venezuela will affect near-term supplies.

4) There is Subjectivity: When it comes to reading a chart, a certain amount of subjectivity comes into play. Some may see a chart and feel that a stock is basing, while another person might see it and conclude that there is still more downside to be had.

So who is right? Again, there’s no calculation that can be done to solve the argument, as might be the case with fundamental analysis. When it comes to charting, only time will tell which way the markets will actually go.

Bottom Line

Technical analysis can be a valuable tool, but it is important to realize the benefits as well as the limitations before diving in. There is no definite answer about whether technical analysis should be used as a substitute to fundamental analysis, but many agree that it has its merits when used as a compliment to other investing strategies. (See also: The Basics of Technical Analysis.)

How to Combine Fundamental and Technical Analysis

Fundamental and technical analysis can complement one another

Fundamental and technical analysis can be combined to provide a holistic trading strategy. Traders often compare the differences between fundamental and technical analysis , however blending the two can have positive benefits. Although there are no hard facts as to which style of analysis is superior, combining the two may lead to more definitive trade choices. This article will explore various ways how to combine fundamental and technical analysis using practical examples.

Ways to combine fundamental and technical analysis

There are numerous ways of combining fundamental and technical analysis. Below are examples of how three different technical analysis methods can be combined with fundamental analysis to provide richer insights including:

  1. Combining range bound trading with fundamental analysis
  2. Combining breakout trading with fundamental analysis
  3. Using oscillators with fundamental analysis

Range bound trading with fundamental analysis

Range bound trading attempts to identify a price channel of a market, by which a trader uses to buy at the lower trendline support and sell at the higher trendline resistance.

The chart below shows a strong bullish (upward) trend on EUR/USD . In a strong up-trending market, traders are looking to enter or buy at the lowest possible level to maximize on the strategy. However, news events can disrupt a range bound market. In this case, the trader would look to avoid open trades around the time of the news release (poor ‘retail sales’ and ‘durable goods orders’ figures). The chart shows clearly this disruption as indicated, after which the price level returns to preceding range bound levels.

Breakout trading with fundamental analysis

A breakout trade strategy involves capitalising on prices of an instrument moving outside of a predefined trading range; often catalysed by news events.

While range traders should remain cautious when going into news releases (since additional volatility could pierce support and/or resistance with which they are using to set their stops), they can still look to take advantage of overreactions to news. Traders in these situations would want to wait for news or data to cause price to reach support and/or resistance – and once a test of either of these levels are put in – could look to buy or sell accordingly. Traders can look to trade breakouts with any of the prescribed mechanisms of support and resistance, with the anticipation that news releases could bring in the wanted volatility to a) trigger into the trade b) move the trade closer to the trader’s profit target (limit).

Using oscillators with fundamental analysis

Oscillators are a frequently used technical instruments, usually to discover short-term overbought/oversold conditions. In the chart above, I have included an example of using an RSI indicator (technical indicator) in conjunction with a Non-farm Payroll (fundamental indicator) data release, one of the most significant fundamental indicators in US history. The NFP figure was lower than estimates, which caused the USD to weaken as depicted by the strong bullish move on EUR/USD . When NFP is due to be released and you expect it to be lower than estimates based on recent events in the US, then this would mean EUR/USD could become more volatile so potentially a good choice to sell and vice versa. Oscillators can further assist with entry and exit points and their respective timing.

Can You Use Both Fundamental And Technical Analysis?

Trading analysis is great way to know what to trade and when to trade. Novice traders often get puzzled about what should they use for analyzing the market.

On the other hand, experienced traders use technical and fundamental analysis combinedly to gather information from the market.

Before that, traders have to learn the basics of two analyses. In this blog post, we will give you a short description of Fundamental and Technical analysis. We will also show you how to use these two complementary types of trading analysis together.

So, to make you understand, we will start with a short description of each of them with features.

What Is Technical Analysis

Technical analysis is a method where you have to use the market data with past prices to predict the future price. Forecasting the future price is the main objective of Technical analysis.

Moreover, you have to use different charts and graphs to identify future assets’ prices. Traders can determine the optimal entry and exit points of trades, by using support and resistance levels.

Furthermore, technical analysis indicators also help traders to find out the most appropriate open and close points. You will find a wide range of trading patterns and signals to support technical analysis trading.

By providing useful information, this analysis help traders to predict the direction of upcoming trends. However, the price chart cannot provide extensive information.

What Is Fundamental Analysis

The fundamental analysis is helpful for traders to forecast the asset price by using real-life events. The asset price can affect depending on what type of corporate news will release.

Furthermore, via fundamental analysis, traders analyze the financial health of a particular company. So, you have to analyze the income statements, balance sheets, cash flow, and other publicly available documents for that.

It is mandatory to state that good news will always positively affect the asset price movement. On the other hand, bad news will negatively affect the intrinsic value and drag the market price down.

How To Combine Technical And Fundamental Analysis

As we said earlier, expert traders use these two analyses together before opening any position. However, you will find some differences between fundamental and technical analysis.

To predict the future price, you don’t have to research on economic data on technical analysis trading. On the other hand, you don’t need to choose any of this between these two trading analyses. Both are useful for traders.

For new traders, it is not an effortless task to combine technical and fundamental analysis. Keep track of recent trading volume. It is wise to check the activity of other traders as well.

Traders can use the volume indicators to check the trend. You will get the signal of an upcoming trend reversal when the trading volume goes down. Similarly, the trading volume will go up when a trend gets momentum.

Additionally, if you use fundamental analysis as the primary analysis tool, you may also use technical analysis for making strategies.

Basically, traders can combine the principle of fundamental and technical analysis. As per the IQ Option analysis team

Traders can trace the connection between fundamental events and signals, received from technical indicators, and use it to spot certain patterns.

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