Stock traders need tools and indicators to predict the future price action of stocks. The tools traders use can be divided into the camps of fundamental analysis and technical analysis. The style which works best for an individual trader is usually dependent on the trader's background, comfort with the tools and trading goals.
Fundamental analysis looks at the financial data of the company behind the stock to determine whether the company's business will result in a higher or lower stock price. Fundamental analysis looks at revenues, profits and losses and business trends, as well as seeking growth factors that will affect the stock price. Fundamental analysis may also review more macroeconomic factors such as a company's business sector and the overall economy in relation to a company's lines of business. Fundamental analysis is geared toward buying the company behind the stock.
Technical analysis of stock prices basically ignores the company behind a stock. Technical analysis looks only at price and volume action. The theory behind technical analysis is all information about a stock is reflected in the share price and analyzing the price movements will predict where a stock price will go from here. Traders using technical analysis rely on stock price charts, which include analytical indicators to help traders recognize price trends or reversals and profit from these expected outcomes.
Pros and Cons
Technical analysis is appealing due the fact a trading system can be developed with a set of rules to trigger buy and sell orders. There is also a wide range of indicators for a trader to choose from, allowing the trader to set up an analysis system to fit his trading style. The negatives of technical analysis are using historical data to predict the future -- which doesn't always work -- and the very large number of confusing signals the different technical tools can generate. Fundamental analysis is more dependent on a trader's judgment concerning a company's financial data. A trader using fundamental analysis can get everything right about a company and stock and still see the stock go in the wrong direction. Fundamental analysis is favored for longer time frames, while technical analysis is considered the better style for short-term trading.
Combining Both Styles
Stock traders should be aware of the other analysis style, even as they choose fundamental or technical analysis for their trading. The fundamental analysis trader can use some stock chart indicators to determine a good entry time or price for a stock his fundamental analysis has shown to be a good buy. The technical analyst can maintain awareness of the fundamental factors which may affect a stock price in a manner different than what the technicals are predicting.
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