There are two general thoughts of analysis when it comes to trading: fundamental and technical analysis. Now, there are also other types of analysis, such as quantitative, but many traders focus on technical and fundamental analysis.
Now, investors and traders use fundamentals in an attempt to find the “true” value of the stock. However, the market doesn’t always agree with the fundamentals. That said, fundamentals are still useful but this type of analysis is both a gift and a curse.
However, that doesn’t mean traders don’t use both fundamentals and technicals to conduct analysis of stocks and options. They know there’s a fine line between the two and use these two schools of thought wisely. If you want to get an inside look behind the millionaire trader mindset, check out this free guide that could teach you how to multiply your money.
Fundamental Analysis: A Gift and A Curse
Fundamentals can be useful in some cases, but it’s general, not wise to use it with “disruptive” companies. For example, take a look at Amazon.com Inc. (AMZN). If you just looked at the fundamentals, you may be compelled to short the stock.
Typically, when you’re using fundamental ratios, such as price-to-earnings ratio (P/E) or price to cash flow ratio (P/CF), you would compare it to the industry average. For example, at a quick glance, when you compare AMZN’s fundamental ratios to that of its index…well, it’s extremely high. Some investors might consider shorting the stock based on this.
However, that wouldn’t be wise. Based on AMZN’s price performance over the years, that short would’ve been a disaster. You see, it’s hard to actually find the “true value” of a stock like AMZN. The market may be pricing in other factors, such as growth potential and potential changes in the industry. On the other hand, these ratios may be useful for more stable companies that have been around for decades like Caterpillar (CAT) or General Electric (GE).
That said, you have to pick and choose your spots when deciding between fundamentals and technicals.
Now, if you want to see how one trader – who turned just over $15K to more than $5M in a few short years – uses fundamentals and technicals to schedule his paychecks take a look here.
Fundamentals vs. Technicals
Some traders will say fundamentals trump technicals, while others will say the exact opposite. If you’re looking for an answer to, “Which type of analysis is better?”…then sorry to tell you, there isn’t a “better” school of thought.
You see, there are traders who make money based on fundamentals, while some purely focus on technicals to put food on the table…others might use a combination of both to multiply their money.
Fundamentals could be helpful in finding what makes the stock price move. For example, if there’s a shift in the fundamentals of the industry, fundamentals would be useful. Now, technical analysis could be helpful with determining the price action. In other words, if you use technical analysis, you might be able to spot a pattern that could signal a stock is poised to run higher.
If you want to learn how to use chart patterns and potentially generate high returns, check out how this former school teacher turned into a trading millionaire using three simple patterns.
That said, you have to figure out which works best for you. Maybe you don’t like fundamentals and focus more on chart patterns. Either way, you have to be comfortable when you’re trading.