"What should I use when looking at the markets, fundamental or technical analysis?"
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This is a question which is regularly asked by who anyone who wants to get into trading and most likely, one of the first questions all of us had when we started looking at the markets.
The dilemma between fundamental or technical analysis as the best way to approach and understand market behavior has always been a hugely controversial debate - especially among beginner or intermediate traders.
Fundamental vs. Technical Analysis - The basics
There are hosts of analysts and traders swearing by the virtues of technical analysis and how it simplifies things by just focusing on price action as it "reflects" all the information they need on a single chart.
According to technical analysts all news, data, opinions and expectations are always priced in on the current market action, so it makes little sense to follow fundamentals. Furthermore, purely technical analysts suggest that those who do follow fundamentals, have already taken into account this information and have acted upon it hence moving the market price to its current level. Simple, right?
On the other hand, fundamental analysts highlight the importance of understanding the basic principles behind market behavior and how changes to this core data affect price action.
They suggest that if someone follows fundamentals and gets a feeling of where the data is headed they can actually foresee which direction the price will follow when fresh data and developments actually find their way into investors' minds and eventually guide their actions. And, it does make some sense. People act upon the changes they notice: fundamental traders act upon the fresh data they receive and technical traders act upon the fresh price action they witness on their charts.
The question then becomes which approach should you adopt, one or the other or both?
Mixed approach
There's little value to providing one, definitive answer as trading is always an activity tailored to one's needs and preferences. One trader's approach rarely fits someone else's needs. What I think would be more beneficial is to provide my own approach to trading and how I combine both disciplines to get in and out of the market. Maybe this way I can provide some insight, a direction on how to think about these two different techniques.
To start with, I have to make it clear that I prefer to combine both disciplines to increase the odds of my trading ideas - I believe that if more evidence points to the same direction then it's more likely that price action will follow suit.
My personal trading methodology has its roots in technical analysis - as this is how I began to understand the markets - but it also incorporates fundamentals as I see a lot of value in following market news and developments. So what I do first thing in the morning is to scan my charts looking for technical patterns like double tops, triangles, reversal formations etc and I build a list of potential trading scenarios.
Then this is where fundamental analysis comes into play. I ask myself: does the direction of these scenarios fall in line with how I expect the market to be affected by upcoming news, fresh data and geopolitical developments? If so, then the trading scenario is translated into a pending order on my platform, if not then I just discard this trade idea and look elsewhere.
Let me give you an example of how this could work. Let's say that I identify a trading opportunity to go long on gold because a double bottom has formed and the price is about to break above a key resistance level. I would then look to see if the fundamental environment supports the idea of gold rallying.
This may include deciding whether, for example, I expect some bearish data for the dollar or a negative development on a geopolitical level, will increase risk-off demand and force traders to buy gold. If so, then I would place an entry order. If my fundamental findings point the other way then I don't want to get into this trade - it might end up a profitable one but I'd rather avoid it as things could get complicated.
After a trade idea has passed my fundamentals "filter" I again go back to technical analysis to identify my exit levels. I will look to place a stop loss and a take profit order close to key technical levels. In this example, a strong resistance for my take profit and a strong support for my stop loss as I am going long on gold.
Don't forget common sense!
I believe that when a trading scenario is triggered and starts to unfold, traders will want to exit their trades near levels that make sense to them and these levels can only be identified by using technical analysis.
One last consideration is, don't disregard the quantitative aspect of trading and I am not referring to the mathematical analysis traders with PhDs undertake. I am talking about simple risk/reward calculations: does my potential profit at least equal my potential loss? In simple terms, what do I stand to gain if the trade hits my take profit compared to what I would lose if my stop loss is hit?
Personally, I would rarely get into trades that don't offer me at least a 1:1 risk/reward scenario. Why would I strive to get 6 out 10 trades right only to lose more money than I make? It's a common-sense approach that helps me get in and out of the markets on a daily basis and I hope it makes sense for you too.
This article was written by Konstantinos Anthis, Head of Market Research at ADS Securities. Join ADS Securities' webinar on Technical VS Fundamental Analysis on June 7th.
