Most traders rely solely on technical analysis. To them, “price is everything”. Most long term investors rely solely on fundamentals. To them, technical analysis is equivalent to reading tea leaves, or what they anecdotally refer to as “just lines on a chart”. I’m somewhere in the middle. I use both technical analysis and fundamental analysis when trading. I am combining the best of both worlds by doing so. Here’s why.
Neither fundamental analysis nor technical analysis is a holy grail
For starters, neither fundamental analysis nor technical analysis is a holy grail. Traders tend to latch on to the trading strategy that first made them money in the markets. So if the trader made his first $1000 in the markets via technical analysis, he will probably end up being a technical trader. If the trader made his first $1000 in the markets via fundamental analysis, he will probably end up being a fundamental trader/investor. As they use a technical or fundamental strategy more and more, it almost becomes a sort of religion. They truly believe in it.
But here’s the simple reality. There is no holy grail in trading. Human psychology – greed and fear – drives the financial markets. Trading is not a science because human psychology is a mix of science and art.
Trading is like the parable about the blind men and the elephant. Each trader only understands one aspect of the market, just like how each of the blind men only understand one part of the elephant. So why would you purposely blind yourself to more data and indicators by ignoring half of the market’s aspects?
Pure technical traders are completely missing out on useful fundamental data. Pure fundamental traders are completely missing out on useful technical signals. Remember, more data is better than less data. More skills are better than less skills.
It’s more common for professional traders to be pure technicians rather than pure fundamentalists. Traders who say “price is everything” are just too lazy to truly understand and learn about fundamentals. The reality is that fundamental analysis is much harder to learn than technical analysis. Anybody can pick up a book about standard analysis from Amazon. Meanwhile, useful fundamental analysis is not what they teach you in standard economics and finance courses.
So remember that we should always be eager to learn more and more as traders and investors.
Fundamentals and technicals are used for 2 different things
Fundamental analysis and technical analysis are used for 2 different things because they are used by 2 different classes of investors and traders.
Fundamentals are used by the big market players: big hedge funds, institutional investors, pension funds, etc. These market players can’t be bothered with technical indicators on a graph. They can’t “buy on the 200 daily moving average” because their buying will cause the market to SOAR above the 200 daily moving average. Their size forces them to take big positions and confines them to fundamental analysis. They aren’t small or nimble enough.
These large investors hold their positions for the medium-long term because they need a lot of time just to get in and out of the market. They are too big. They can’t profit from small short term fluctuations in the market.
Hence, these large investors have the biggest impact on the market’s medium-long term direction. They are using fundamentals to place these medium-long term trades, so fundamentals determine the market’s medium-long term direction.
Even short term traders need to know the market’s medium-long term direction. This is because
- The market goes up more often that it goes down in a bull market.
- The market goes down more often than it goes up in a bear market.
Trading is all about probability. The odds will be stacked against you if your trades go against the market’s long term trend. You need to understand fundamentals to know the market’s long term trend.
*A lot of traders are weird, for lack of a better word. They see fundamentals as a bunch of conspiracy theories. They “fit” the fundamentals to their predetermined market view. Focus on the data. Ignore the BS opinions.
Technical analysis tends to be used by small market players because traders are terrible at understanding fundamentals. Understanding fundamentals takes years, and these traders typically don’t bother to study those fundamentals in depth. They believe in conventional “wisdom” when it comes to fundamentals, and this “wisdom” tends to be wrong more often than it is right. (For example, they think that rising interest rates is bearish for stocks. History proves otherwise.) Everyone can draw a few lines on a chart. Understanding fundamentals takes much longer.
These small market players tend to be short term traders. Their small size allows them to be more nimble. These short term traders tend to do the same thing because they all learned the same technical analysis. For example, they all “buy when momentum is oversold” or “buy when the market his its 200 sma support” because that’s what standard technical analysis books teach them. In aggregate, these short term traders are big enough to have a significant impact on the market’s short term direction. That is why technical analysis drives the market’s short term.
So as you can see, both fundamental analysis and technical analysis have flaws. Technical analysis can be used to make up for fundamental analysis’ flaws, and fundamental analysis can be used to make up for technical analysis’ flaws. The best traders and investors combine both.
Fundamental analysis cannot be used to pick an entry and exit price. It can give you a general BUY or SELL indication, but it can’t help you pick better entry and exit prices. That’s where technical analysis steps in.
In addition, sometimes the market’s fundamentals aren’t clear or are neutral. This causes the market to swing sideways in a wide range. Technical analysis works best during this market stage.
On the other hand, technical analysis has a big flaw. Technical analysis tends to become useless when the market’s fundamentals are strong enough. For example, the economy and corporate earnings were on fire in 2017. The market soared nonstop and ignored all technical sell signals. You need to know what the fundamentals are in order to predict when the market will soar or crash nonstop.