Technical and fundamental analysis are two principal disciplines when investing in markets, but they are on opposite sides of the spectrum. Therefore, investors want to know if technical analysis can be an effective alternative to fundamental analysis.
Although there is no final answer to this query, there is little doubt about combining the strengths of both these techniques to help investors better appreciate the market and speculate the direction in which their investments might be heading.
In this discussion, let’s take a look at which elements of technical analysis work well with fundamental analysis and also discuss some of the drawbacks of combining technical analysis with fundamental analysis.
Which Technical Analysis Elements Work Well with Fundamental Analysis?
Pursuing Feedbacks Over Time
Many fundamental experts will look at a graph of a certain market, stock, or index to conclude how that item has done over time and when specific kinds of news such as financial data or positive earnings will be released.
Trends have an affinity of repeating themselves, and the traders who were tempted or put off by the news in question happen to respond in a similar way over time.
For instance, if you look at the graphs of housing stocks, most of the time, you’ll note that they respond negatively when the US Federal Reserve decides to waive a portion of the interest rates. Also, interior fittings stores are affected when sales of new and existing homes drop.
When an investor or analyst studies stocks, it’s always good to hear what other analysts think about the stock. Maybe they might have gotten some extra information about the company, or they could be creating a pattern.
One of the most common means of judging market sentiment is to focus on the freshly traded volume. Massive trades imply that the stock has gotten a lot of attention from the trading industry, and the shares are either under accrual or circulation.
Pursuing Short-Term Movements
Although a majority of fundamental traders happen to focus on the long-term, odds are that they still need to get a favorable entry price or a favorable exit price after they stop holding a position. Technical analysis can come in very handy in such scenarios.
More precisely, when a stock breaks its 20 or 30-day moving average (MA) either up or down, it normally proceeds along that pattern for some time. In layman’s terms, it’s mainly an illustration of what to expect in the imminent period.
Also, 50 and 200-day MAs are typically used by some fundamental traders and chartists to conclude long-term breakout trends. For investors looking for the opportune moment to trade or set a favorable entry or exit price, these kinds of analyses are vital.
What Are the Drawbacks of Combing Technical and Fundamental Analysis?
Technical analysis can give an incorrect perspective because:
There is Bias
When it comes to examining a chart, a certain level of bias comes into play. For instance, some people may see a chart and presume that the stock is stalling, while others might see this and decide that there is an immense loss to follow.
So who is correct? There is no definitive answer because there’s no computation that can be done to settle this argument, as is the case in fundamental analysis. In charting, only time will reveal the direction in which markets move.
Although it’s possible to predict some changes based on trends or when a certain stock breaks past a significant moving average, charts usually don’t forecast future positive or negative fundamental information. Instead, they are mainly focused on the past.
For instance, if word gets out that a company is about to release outstanding quarterly earnings, investors might be able to exploit this prospect, and the good news will be evident in the chart. A basic chart cannot give an investor vital long-term fundamental data such as the imminent direction of price per share or cash flow.
Charts Don’t Constantly Predict Macro Trends
Charts are generally incapable of predicting macroeconomic patterns accurately. For instance, it’s almost impossible to look at a key figure in the oil and gas industry and conclusively tell whether OPEC plans to amplify the quantity of oil its producing.
All in all, there is no conclusive response as to whether technical analysis can be used as an alternative to fundamental analysis. However, most analysts agree that it has its benefits when used to complement rather than replace fundamental analysis.