Technical Analysis vs. Fundamental Analysis (Definitions)

By Indeed Editorial Team

Published May 29, 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Financial traders often differ on the optimal approach for predicting the stock market's direction. Short-term and long-term traders sometimes use different tactics when determining the ideal investments to make. Learning about the various strategies used by professional traders can help you make better investment decisions and increase your earnings. In this article, we compare technical analysis vs. fundamental analysis, discuss their differences, and explore strategies that day traders use.

Technical analysis vs. fundamental analysis definitions

If you want to follow a professional career as a stock trader, you may benefit from comparing technical analysis vs. fundamental analysis. You can start comparing both through their definitions:

Technical analysis

Technical analysis is a technique for forecasting stock market or other securities market movements based on data from recent periods. Because of this, day traders and other short-term traders rely heavily on technical analysis. It also has certain applications in long-term trading, such as assisting with market timing. Technical analysis makes trading judgments by analyzing price activity, such as increases in trading volume or stock price. Technical analysts often execute trades based on buy-and-sell indications generated by market patterns.

Moving averages, relative strength indices, and on-balance volumes are often useful to technical analysts to help them better assess trends and justify trading choices. To calculate a stock's moving average using daily high values over 10 days, for example, you might sum up the daily high values for the previous 10 days and divide them by 10. Technical traders sometimes study the dynamics of several moving averages, such as a 50-day and a 200-day average, to justify buy and sell signals more effectively.

Related: A Guide to Risk Management Process (With Practical Examples)

Fundamental analysis

Fundamental analysis is also a technique for forecasting market movement, although it's reliant on long-term data. Fundamental analysis, at its most basic level, is the process of discovering the true worth of a stock, currency, or commodity, as opposed to its exchange list price. If a trader determines via fundamental research that a stock is worth more than its current listing price, they say the stock is selling at a discount. If the price exceeds the intrinsic value, the stock is trading at a premium.

Fundamental analysts may ascertain a company's true worth by examining its goods or services, the predicted growth of the market or industry, and the company's raw sales statistics. Fundamental analysts advise investing in a firm if they believe it can generate greater revenue in the future.

Common differences between technical and fundamental analysis

The primary distinctions between these two types of analysis are the types of data analyzed and the investment categories you may consider during the analysis. Here is a list of differences:

Term of investment

Technical analysis is more often useful for short-term trades than long-term trades because its techniques are effective in sensing market shifts, evaluating data, and identifying timing tactics. Numerous variables may influence a stock's short-term price fluctuation, including the release of a new product, growth into a new area, supply and demand, and market sentiment.

Technical analysts focus their attention more closely on these short-term trends to profit from extensive price swings. Fundamental analysts often invest in long-term security transactions, or until the asset's worth equals or exceeds its price. For instance, if a company is developing new technology but has not yet revealed it to the public, investors may profit from the company's future worth by investing before the technology's release. These future situations often require months or even years to materialize, making fundamental research more effective for long-term transactions.

Related: How to Become an Equity Trader (With Steps and Salary)

Determining characteristics

A technical analyst's determining characteristics for making an investment largely relate to current trading volume. For instance, even if a company has gone bankrupt, its stock price may still go up in the short term, allowing some traders to take advantage of the increase. Alternatively, some high-value companies see sudden short-term drops in stock price because of a decrease in purchases of the stock.

Fundamental analysts usually determine trading decisions through the use of value analysis. They base their decisions on revenue, profitability, and growth potential, rather than current trading volume. Analysts use the price-to-earnings ratio (PER), earnings per share (EPS), debt-to-equity ratio, and dividend yield to better determine the actual value of a security.

Market timing

Short-term traders use technical analysis to help guide their market timing decisions. For example, sudden drops in volume or price for a stock that is currently in a stage of growth can drive short-term traders to invest, hoping a rebound may occur sometime soon. Long-term traders may occasionally use a technical analysis if they're hoping to maximize their return even more effectively.

In fundamental analysis, the time to invest occurs as soon as you determine that a company is currently trading for significantly less than its current or future value. There is little reason to wait for the price to decrease subtly before investing, because fundamental analysts believe the future price may exceed any daily price swings that are occurring. For instance, a stock may fluctuate 10% in value within a week but increase over 400% in a few years.

Chart usage

Technical analysis relies heavily on the use of charts. Stock charts provide valuable information, such as current trading volume, buy and sell walls created by limit orders, and historically high and low values. Charts also provide the ability to visualize a security's price over time, allowing for discernable analysis of a security's movements.

Fundamental analysis may use charts to help determine the value of a security using the PER, EPS, debt-to-equity ratio, and dividend yield. For instance, stock charts usually include the dividend yield, which is a regular payment made to investors based on their current investment within a stock. These dividends can help increase the long-term gains investors receive from their holdings, as some stocks provide dividends upwards of 2%.

Related: How to Start a Hedge Fund Career in 8 Steps (With Jobs)

Types of positions

Because technical analysts seek short-term returns, they often take short positions, which means they owe money to someone before they own the stocks. Traders that use technical analysis may enter short positions in response to a sell signal, increasing the rate of return on their short-term investments. Technical analysts may take long positions when they feel the price of an asset may rise soon.

Long-term investors often exclusively purchase long positions, which are stocks that an investor purchases and holds, since valuable equities nearly always appreciate over time. This significantly reduces the value of short positions for investors that use fundamental analysis. Certain long-term traders may utilize larger leverage to raise additional funds for their trades, but this technique carries a higher risk. If the security's price falls significantly, the investor may lose their whole investment. Many long-term investors choose to acquire solely classic long holdings.

Strategies of a day trader

Here are some strategies that a day trader might use during their trading activities:

Scalping

A day trader may seek to benefit from multiple tiny price fluctuations during a trading day. This technique has its basis on the assumption that a stock may finish the first stage of its journey through a market and enjoy a little gain in price. Once this price gain happens, a day trader may sell the stock or wait to see whether the price continues to rise. A day trader often employs this strategy with many equities to maximize earnings.

Range trading

This strategy entails strategically purchasing and selling a stock over a short period. A day trader may use this method to determine a range within which to purchase and sell a certain stock. They may use this range to guide their purchasing selections. For instance, if a stock's market price is $50, a day trader may forecast a price increase to $60. They may trade between these prices by acquiring the stock at $50 and selling it at $60.

High-frequency trading

High-frequency trading makes use of computer programs and algorithms to purchase quickly and sell a huge number of equities. These computers do market analysis and place orders depending on the information they obtain. Day traders may utilize high-frequency trading to purchase and sell stocks more quickly and accurately than they might manually.

Arbitrage

A day trader may purchase and sell the same item in several marketplaces with minor price changes. They may benefit from price fluctuations by acquiring an item at a discount in one market and selling it at a profit in another. A day trader may use an automated trading strategy to monitor many markets.

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