The Ultimate Guide to Analysis: Technical vs. Fundamental
Day traders use technical and fundamental analysis when trading securities. While technical analysis is used much more than fundamental analysis, both play a role in successful day trading. As traders hone their trading strategies they will discover which type of stock analysis best suites their purpose. The bottom line is that stock analysis, whether technical or fundamental, seeks to reveal future stock and market activity.
What is Technical Stock Analysis?
Day traders don’t focus on stock price per se with technical analysis. It’s a matter of focusing on the statistical analysis of the stock’s price movements. In essence, technical analysis involves predicting a stock price’s future direction by examining past data. Technical analysis requires a thorough understanding of technical charts. The use of technical charts and the examination of price and volume history reveal long-term patterns. Technical stock analysis looks at the way market factors affect a stock but not necessarily factors affecting the market. The latter is more the purview of fundamental analysis.
What is Fundamental Stock Analysis?
Unlike technical analysis, price is the primary focus with fundamental analysis making it nearly an opposite system. You want to find the fundamental, or intrinsic, value of the security. Anything that affects a company’s value is a component of fundamental analysis, whether that concerns major influences such as the overall economy or specific factors such as company management, revenue, earnings growth and profit margins. Rather than using technical charts, traders look for hard data for security evaluation. A company’s financial statements are the starting point.
Because day traders are interested in very short-term – 24 hours or less – gains and losses, fundamental analysis is not as crucial a tool. However, for longer-term traders, it’s an absolute necessity. Market legend, Warren Buffett relies heavily on fundamental analysis when choosing stocks.
Technical Analysis Tools
There’s no shortage of technical tools for day traders, therefore, the tools used boil down to experience and personal preference. Some technical tools will show basically the same information, so there is no need to use redundant indicators. For best results, rely on one of the indicators in each of these four sectors:
Oscillators – among the common tools, oscillators generally range from 0 to 100 with the former showing oversold conditions and the latter overbought conditions. The most popular oscillators include:
- Commodity Channel Index (CCI) – despite the name, this indicator works with any type of security, not just commodities. It measures a security’s current price level compared to the average price level over a specific period. When prices are above average, the CCI is high. When the prices are below its average, the CCI is low. This allows the trader to clearly ascertain overbought and oversold levels.
- Moving Average Convergence Divergence (MACD) – this tool consists of a fast and slow line, comparing two different moving averages. The exponential moving average (EMA) is compared at 26 days and 12 days with the latter subtracted from the former to calculate the MACD- that’s the bottom line. The top line, called the signal line, consists of an EMA nine-day average functioning as the signal for buying and selling.
- Relative Strength Index (RSI) – this oscillator measures a price’s movement, change, and speed. Generally, an RSI above 70 indicates overbought conditions while below 30 is considered oversold. In an up market, the RSI usually ranges from 40 to 90 with 50 as the support base. In a downward market, the RSI predominately stays between 10 and 60 with 50 serving as the resistance.
- Stochastic – this momentum indicator compares a security’s closing price to its price range over a certain time frame. When the market trends upward, closing prices are near the high and when trending downward, closing prices are near the low.
Volume indicators – volume indicators aren’t absolute necessities but they can help traders make decisions. Such indicators deal not only with volume but with price data to determine trend strength. The best-known volume indicators include:
- Chaikin Money Flow (CMF) – used in conjunction with a moving average, this indicator measures a security’s buying and selling pressure over a specific period. The CMF aids a trader in figuring out future changes.
- Money Flow Index (MFI) – uses price and volume for buying and selling pressure measurement.
- On Balance Volume (OBV) – this momentum indicator predicts stock price changes via volume flow.
Overlays – these indicators are the exception to the “choose one” rule, as different overlays serve different functions. They get their name because these indicators are found on the top of price bars and use the same price scales. The most commonly used overlays include:
- Bollinger bands – this shows higher and lower limits of price movements as per the standard deviation of prices.
- Keltner channels – based on an average true range of prices, this overlay shows a price movement’s highest and lowest limits.
- Moving averages – this overlay uses either simple moving averages or exponential moving averages to provide the average price over a specified timeframe.
- Pivot points – in an uptrend, this overlay reveals reversal points and in a downtrend, shows above points.
Breadth indicators – these indicators show overall market sentiment, whether bullish or bearish. The most used breadth indicators include:
- Arms Index – also known as the Trading Index, or TRIN, this indicator is used by many day traders as its measurement of basic market supply and demand can predict very short-term price movements.
- Tick Index – based on the New York Stock Exchange data, the Tick compares upticking and downticking stocks.
- Tiki Index – basically the same as the Tick but based on the Dow Jones Industrial Average data.
Using Technical Trading Strategies
Once a trader masters technical analysis tools, it’s time to use them and learn technical trading strategies. Familiarity with the top trading strategies allows a trader to find the best-suited method for his or her individual trading style. Here are the major technical trading strategies:
Breakout Stock Trading
With breakout stock trading, traders look for each security’s price resistance and support level. The former is indicative of a price the stock can’t quite reach and the latter, a price at which the stock does not go below. Breaching of that resistance point results in high volume trading. Traders must learn certain patterns in technical charts to seize an upward trend and capitalize on the breakout. Knowing the correct exit point is critical for this strategy.
Simple Moving Averages (SMA)
Sophisticated technical charting isn’t necessary for determining simple moving averages. SMAs are easy enough to figure out on a calculator. You do need to see the SMA on a chart to quickly determine trending and whether to buy or sell based on the SMA trend signal. There are many varieties of SMAs, but most pertain to specific timeframes that may involve weeks, days, hours or minutes.
Trading with trend strategies is relatively simple, but the key is the usage of a variety of indicators and analysis. Depending on a security’s direction, traders assume long position or short positions on a stock. For trend trading, you need SMAs, RSIs and volume measurements.
An easy strategy to master, trading with swing strategies begins with identifying the trend using candlestick charting. However, this is not a day trading strategy but a longer-term strategy. Once you’ve identified the trend, patience becomes a virtue as you wait for gains.
With range strategies, traders find a security’s support and resistance level with the help of oscillators. The stock is purchased at the overbought level and sold when close to the resistance level. Range trading works as either a short or long-term strategy, depending on the trader’s preference.
Using Fundamental Analysis
Whether you day trade or take a long-term approach, understanding and using fundamental analysis is critical. Fundamental analysis is really the foundation of investing and virtually every investment strategy uses it. Much of fundamental analysis involves number crunching and learning the nitty-gritty of a particular company through examination of its assets, liabilities, expenses, and revenues. If you enjoy doing research when investing – and no one should invest without researching a security – you’ll find fundamental analysis compelling. Used correctly, fundamental analysis is the best way to pick stocks – just ask Buffett.
Get started on your fundamental analysis by accessing and dissecting a company’s financial statements, especially the balance sheet, income statement and cash flow statement. Here’s what you’ll learn from perusing these documents:
- Balance sheet – a statement of the company’s assets, liabilities, etc. at a specific time. You’ll learn what the company owns and what it owes, along with shareholder investment amounts.
- Income statement – a company’s financial performance during a particular time period and also known as a profit and loss statement. This document reveals a company’s profitability – or lack of it – over a year or quarter.
- Cash flow statement – the overall incoming and outgoing cash amounts for a certain time period. Compare the cash flow from its operating activities to the company’s net income.
Learn how to perform fundamental analysis by tracking a few stocks over two or three months. Do your homework and decide on the direction of the stock based on its fundamentals. After careful tracking for the three-month period, see how each stock fared compared with your analysis.
The SureTrader Advantage
SureTrader’s state-of-the-art platform offers top technical analysis tools for clients. Whether you’re a novice investor or have decades of experience, you’ll find our technical and charting tools second to none. Along with our low minimum balance and 6:1 leverage, our technical offerings are just another part of the SureTrader advantage.