A Big Decision To Make

Technical analysis and fundamental analysis sometimes differ in the decisions made but the following example should help show just how big a difference:

Let us assume that shares in Tesco (TSCO.L) are currently trading at 375p.

If the price starts to trend upwards, the technical analyst may view his indicators and conclude that the trend is likely to continue and will buy Tesco.

On the other hand, a fundamental analyst may decide that Tesco’s intrinsic value is 360p and so will sell Tesco.

The two different approaches have, in this very particular example, contradicted each other in terms of the action being taken. One of them will clearly lose out.

Or will they?

The point to make here is that while those using technical analysis will often trade only while the trend is apparent, fundamentalists are most likely thinking more long term.

So if the price of Tesco reaches 425p, the technical indicators may then suggest that the trend is over and that anyone holding Tesco should sell. Thus the technical analyst has made a profit.

If some undisclosed period later Tesco shares drop below 275p then the fundamentalist was also correct and he or she will also make a profit. It is in fact likely that the fundamentalist was going short at many different points during the upward cycle.

So which method is better?

To answer this question you need to ask yourself two important questions.

Firstly are you looking for quick price movements to make regular smaller profits or have you got a much longer investment horizon? Fundamental analysis does not cater for short term movements but has the advantage if you are looking to buy and hold shares for a longer period.

How much time have you got to spare? While fundamental analysis can be very time consuming at first, once the initial purchase has been made there is zero effort required until you come to sell.

Technical analysis on the other hand requires regular monitoring in order to get the optimum entry and exit points for a trade. For day traders this can be a full time occupation.

Is it a case of one or the other?

The answer, unsurprisingly, is no of course you don’t have to use these techniques in isolation. Certain instances will require the individual use of one method (e.g. day trading, swing trading, and short term horizons all require the almost solitary use of technical analysis) but on most occasions an investor should adopt a combination of both.

For instance a fundamental analyst might identify a stock that he/she thinks is underpriced but then might look at the charts and find that the stock is actually at a local, short term, top and so will wait a few days/weeks before buying in at an even lower price in order to maximise profits.

My Advice

As an active trader myself I know the importance of finding your own balance between fundamental analysis and technical analysis so that you can quickly and comfortably identify trading opportunities.

To aid me in my fundamental analysis I will often follow the newspapers share tips column and participate in active share trading forums but I will always make my own decisions and I suggest that you do the same.