You’ll need a starting point as you begin analyzing the markets, specific market sectors, or individual stocks for potential trades. You may want to focus on one style or use a blend of styles. Most traders define their approach based on technical analysis, fundamental analysis, or a blend of both. Each approach is based on a view of what drives market movement.
The underlying premise of technical analysis is that everything that is known by market participants about a company is reflected in its stock price. Therefore, technical analysts believe that understanding “how” a stock’s price and volume have moved in the past can help you identify opportunities. Technical traders weigh technical indicators more heavily than stock fundamentals.
Technical analysis involves using price and volume data to identify characteristics that may signal future price movement. These characteristics fall into two broad categories: patterns and studies. Patterns reflect the graphical representation, or chart, of a stock’s price over time. The idea behind patterns is that, historically, a stock chart that is behaving in a particular manner may display specific characteristics going forward. Technical studies are mathematical calculations of price data that may provide insight into the strength of that price movement, its direction, or its current behavior vs. historic pricing. It is important to note that there is no guarantee that any particular pattern or study will provide the right answer; they are simply directional indicators based on past behavior.
The underlying premise of fundamental analysis is that you can identify good times to buy and sell by closely evaluating a company’s value relative to its price. The value is defined by a variety of measures, such as earnings, debt, revenue growth, products, and management to name a few.
Fundamental analysis is the evaluation of a firm’s performance, health, and ability to generate cash, as well as more qualitative measures like market sentiment, management, competition and product outlook. Most of the information used in fundamental analysis is gathered by the company’s own financial statements: the income statement, balance sheet, and statement of cash flows. Information from these statements is evaluated over time and against comparable firms to assess the company. Ratios are used to measure a company’s performance across more than one variable. Schwab equity research tools can help provide a great starting point for fundamentally driven investors to start their research.
While technical and fundamental analyses have their roots in very different views on the markets, this does not mean that they are mutually exclusive. You will also find traders that use both technical and fundamental analysis together to meet their trading objectives. For example, a blended approach might use fundamental analysis to identify the quality of a stock or security, then switch to technical analysis to determine entry and exit points. Or the opposite approach could be taken where technical analysis is used on broad indicators to identify over- or under- sold markets, then fundamental analysis is used to select the trading candidates.
Becoming a successful trader
Regardless of approach, there is an abundance of information available to traders. With fundamental data and reports; a myriad of technical indicators; plus weekly, monthly and even minute-by-minute trader commentary; it can be challenging to choose and process all of the pertinent data. The inability to make a decision due to “too much” data, is known as analysis paralysis.
In order to overcome analysis paralysis, a trader must decide what information is important and how he or she will actively access and filter such information. Many traders start out thinking that more is better in terms of technical indicators, fundamental data, research reports and news. However, this doesn’t necessarily translate to a more effective trading method. Some argue that a simple trading approach can be the most effective.
To address analysis paralysis, determine which type of analysis provides the best match for your trading style, trading objectives, and personality. Then, identify key measures that are a good fit for your trade objectives and trading style. Focusing on a few specific measures at a time will allow you to understand them. Many successful traders focus on just a handful of measures, which helps them to filter out the noise of the market and gives them the opportunity to scan for the trade opportunities that best fit their trading style and objectives. Becoming a successful trader will mean finding an individual comfort level.
Technical analysis, fundamental analysis and a blend of the two are the primary analysis approaches. Technical analysis focuses on past price and volume as an indicator of possible future price movement. Fundamental analysis looks at a firm’s performance, as measured primarily by its financial statements, to determine whether it is over or under valued. The approach you select should align with your trading strategy as well as your trading strengths and interests. Be diligent in determining what measures you will use, regardless of the approach you take, as there are many and they can quickly become overwhelming.