Fundamental Analysis and Technical Analysis are two separate schools of thought used by traders to gain a deeper understanding of trading opportunities, and to forecast the likely future price movements of different tradable assets.

Traders may use either one of these analysis methodologies exclusively, or a combination of both, in order to break down an asset’s current price value in relation to past prices and predicted future prices.

While Fundamental Analysis focuses on assessing the intrinsic value of the asset, or its ‘fundamentals’, Technical Analysis focuses solely on the chart-based data of the asset which stems mainly from its previous pricing and trade volume metrics.

Fundamental Analysis and Technical Analysis are widely-practiced by traders, both within traditional trading markets such as forex, commodities and stock indices, and within emerging digital currency markets such as Bitcoin, Ethereum and altcoin markets.

Fundamental Analysis

The underpinning concept behind Fundamental Analysis is that the current value of an asset should be a reflection of macroeconomic factors (such as the state of the global economy or regulatory conditions for that industry etc) and microeconomic factors (such as considerations relating to the supply and demand).

Analysis produces a quantitative measure of what is intended on being as close to a true valuation of the asset as possible. Any deviation from that valuation then indicates the asset being either overpriced at current market rates, or underpriced. An indication that this deviation is present can then be used to formulate strategies leading to the creation of the appropriate long or short positions against the asset.

Fundamental Analysis is typically a comprehensive process based around the gathering, compiling and examination of various types of publicly available information such as press releases, news, reports and statistic bulletins. Any revelations about the state of the asset are derived solely from data which is sourced externally of trading charts, and this is the basic difference between Fundamental Analysis and Technical Analysis.

Fundamental Analysis typically begins with a top-down approach. This starts with observing the state of the general economy and then progressing to look at the sub-economies and industries within that, and then finally comparing indices, commodities or blockchain projects.

Technical Analysis

As the price of a stock, forex pairing, cryptocurrency or any other financial asset moves over time, globally-shared recordings of its valuation history are created and stored as charts.

Technical Analysis is the study of the patterns that are created within these charts. The underlying concept is that with an understanding of group psychology, and the use of a range of chart-based indicators, future price movements can be effectively predicted and acted upon profitably.

Technical analysis by PrimeXBT

At its core, Technical Analysis looks at the historic price movements of an asset, as well as the volumes that have been traded over time. These metrics are further used to create important indicators such as MACD, RSI and various ‘moving averages’, with each indicator being used to reveal deeper insight into the reasoning behind past price movements and to be used to forecast future trends.

Rising Wedge pattern

A key factor in the effectiveness of Technical Analysis is that when a large group of traders all share the same chart data and the same beliefs about the meaning of certain events and patterns, this essentially creates a self-fulfilling prophecy.

For example, RSI is an indicator that shows if an asset may be ‘oversold’ or ‘overbought’, signaling to traders that a converse trend may be impending. While there is no absolute rule that oversold assets must then see price increases from increased buying, the implication is that traders who see this will then begin to buy the asset.

As a result, traders begin to buy with the hopes of preceding a price increase and making a profit, the price of the asset then increases due to increased buying, and this then reinforces the concept that the asset was indeed oversold.

Fundamental Analysis vs. Technical Analysis

When fundamental analysts might say that they are going long on a stock index such as the Japanese Nikkei because of increased levels of investment, liquidity and profitability of the stocks within the index, a technical analyst may base the decision to short Bitcoin on the 50-day moving average crossing under the 200-day moving average.

There are strengths and weaknesses of both systems, and while practitioners of each may tout the reasoning for why one method may be superior, in truth, a healthy knowledge of both is important for a rounded understanding of what really drives global financial markets.

Pros of Fundamental Analysis:

Fundamental Analysis factors in an understanding of external factors such as developments in the global economy which cannot be preemptively understood using Technical Analysis.

Unexplainable chart events may be understood when looking at fundamental factors. New events, for example, may impact the price of an asset.

Fundamental Analysis provides a more robust tool for forecasting when creating long term investments in many asset classes.

Cons of Fundamental Analysis:

New events that analysts are expecting to impact a market may have already been factored into the current price, and therefore have negligible effect.

Fundamental Analysis often requires significant amounts of time to process, including the gathering and processing of large bodies of information.

For effective Fundamental Analysis, an understanding of various economic concepts and metrics is important.

Pros of Technical Analysis:

Specific entry and exit points are readily able to be created using Technical Analysis. For Fundamental Analysis, this can often be much more complicated.

Reading and understanding trading charts is often much more intuitive and a lower barrier to entry for many traders than studying financial and corporate information.

Whether by the absolute truth in technical indicators or from the psychology behind the results that they produce, Technical Analysis can and does create reliably profitable strategies for use across all asset classes.

Cons of Technical Analysis:

Relying solely on chart data ensures that external macroeconomic events are unforeseen, opening strategies up to unpredictable price movements.

Technical indicators are largely trailing indicators by their nature, which means that they are composites of previous price and volume information. While future price actions can be predicted with the assistance of these indicators, it is easy to mistakenly believe that current patterns will always continue in the future.

In summary, the logic behind trading strategies for any asset class can be broken down into these two distinct schools of thought.

It can be seen that Fundamental Analysis is useful when making longer-term investments.

Conversely, Technical Analysis ignores the background information available in the real world and instead generally suits shorter-term trading strategies based solely around patterns and events within the asset’s trading charts.

There are certainly wider applications of each, as well as there being incentives to using a crossover of both methodologies together in certain situations. Selecting the right entry point through the use of Technical Analysis for a fundamentally-strong asset is a logical way to approach financial trading.

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