Introduction on how to be a good traders----Part 2

We are now continue the Part 1 in earlier posting......

TECHNICAL ANALYSIS & FUNDAMENTAL ANALYSIS

Technical analysis and fundamental analysis are the two main schools of thought in

the financial markets. As we've mentioned, technical analysis looks at the price

movement of a security and uses this data to predict its future price movements.

Fundamental analysis, on the other hand, looks at economic factors, known as

fundamentals. Let's get into the details of how these two approaches differ, the

criticisms against technical analysis and how technical and fundamental analysis can

be used together to analyze securities.

The Differences

Charts vs. Financial Statements

At the most basic level, a technical analyst approaches a security from the charts,

while a fundamental analyst starts with the financial statements

By looking at the balance sheet, cash flow statement and income statement, a

fundamental analyst tries to determine a company's value. In financial terms, an

analyst attempts to measure a company's intrinsic value. In this approach, investment

decisions are fairly easy to make - if the price of a stock trades below its intrinsic

value, it's a good investment. Although this is an oversimplification (fundamental

analysis goes beyond just the financial statements).

Technical traders, on the other hand, believe there is no reason to analyze a

company's fundamentals because these are all accounted for in the stock's price.

Technicians believe that all the information they need about a stock can be found in

its charts.

Time Horizon

Fundamental analysis takes a relatively long-term approach to analyzing the market

compared to technical analysis. While technical analysis can be used on a timeframe

of weeks, days or even minutes, fundamental analysis often looks at data over a

number of years.

The different timeframes that these two approaches use is a result of the nature of the

investing style to which they each adhere. It can take a long time for a company's

value to be reflected in the market, so when a fundamental analyst estimates intrinsic

value, a gain is not realized until the stock's market price rises to its "correct" value.

This type of investing is called value investing and assumes that the short-term

market is wrong, but that the price of a particular stock will correct itself over the

long run. This "long run" can represent a timeframe of as long as several years, in

some cases.

Furthermore, the numbers that a fundamentalist analyzes are only released over long

periods of time. Financial statements are filed quarterly and changes in earnings per

share don't emerge on a daily basis like price and volume information. Also

remember that fundamentals are the actual characteristics of a business. New

management can't implement sweeping changes overnight and it takes time to create

new products, marketing campaigns, supply chains, etc. Part of the reason that

fundamental analysts use a long-term timeframe, therefore, is because the data they

use to analyze a stock is generated much more slowly than the price and volume data

used by technical analysts.

Trading Versus Investing

Not only is technical analysis more short term in nature that fundamental analysis, but

the goals of a purchase (or sale) of a stock are usually different for each approach. In general, technical analysis is used for a trade, whereas fundamental analysis is used to make an investment. Investors buy assets they believe can increase in value, while traders buy assets they believe they can sell to somebody else at a greater price. The line between a trade and an investment can be blurry, but it does characterize a difference between the two schools. The Critics Some critics see technical analysis as a form of black magic. Don't be surprised to see them question the validity of the discipline to the point where they mock its supporters. In fact, technical analysis has only recently begun to enjoy some mainstream credibility. While most analysts on Wall Street focus on the fundamental side, just about any major brokerage now employs technical analysts as well. Much of the criticism of technical analysis has its roots in academic theory - specifically the efficient market hypothesis (EMH). This theory says that the market's price is always the correct one - any past trading information is already reflected in the price of the stock and, therefore, any analysis to find undervalued securities is useless. There are three versions of EMH. In the first, called weak form efficiency, all past price information is already included in the current price. According to weak form efficiency, technical analysis can't predict future movements because all past information has already been accounted for and, therefore, analyzing the stock’s past price movements will provide no insight into its future movements. In the second, semi-strong form efficiency, fundamental analysis is also claimed to be of little use in finding investment opportunities. The third is strong form efficiency, which states that all information in the market is accounted for in a stock's price and neither technical nor fundamental can provide investors with an edge. The vast majority of academics believe in at least the weak version of EMH, therefore, from their point of view, if technical analysis works, market efficiency will be called into question. Can They Co-Exist? Although technical analysis and fundamental analysis are seen by many as polar opposites - the oil and water of investing - many market participants have experienced great success by combining the two. For example, some fundamental analysts use technical analysis techniques to figure out the best time to enter into an undervalued security. Oftentimes, this situation occurs when the security is severely oversold. By timing entry into a security, the gains on the investment can be greatly improved. Alternatively, some technical traders might look at fundamentals to add strength to a technical signal. For example, if a sell signal is given through technical patterns and indicators, a technical trader might look to reaffirm his or her decision by looking at some key fundamental data. Oftentimes, having both the fundamentals and technicals on your side can provide the best-case scenario for a trade. While mixing some of the components of technical and fundamental analysis is not well received by the most devoted groups in each school, there are certainly benefits to at least understanding both schools of thought We shall continue next.......... Happy Trading