As a beginning trader, you will encounter the term technical analysis and fundamental analysis pretty soon. Somehow there has always been heated debate between traders on which one is the best and why the other one doesn't work. In this post, we’ll discuss both types of analysis and find out if they work, which one is most used by professional traders, and give you some tips on which one might be suited for you.
So do professional traders use technical analysis?
Studies show that the vast majority of professional traders use technical analysis for their trading. Statistically speaking, 80% of all professional traders use technical analysis, while the remaining 20% opt for other techniques such as fundamental analysis.
In the following paragraphs, we’ll try to explain the basics of fundamental analysis & technical analysis and why we think most traders are better in choosing for technical analysis.
Fundamental analysis vs. technical analysis
Saying which type of analysis is "better" varies from person to person. There are some well-renowned names such as Warren Buffet who has not used technical analysis at all but yet became one of the most successful traders. Some might argue he’s more of an investor than a trader since he only takes on long term positions. While this is true it doesn’t change the fact he’s very successful without doing any form of technical analysis. Another great source for this topic is the books written by Jack Schwager. He wrote "Market Wizards" in 1989 and later on ”The New Market Wizards” in 2008" and “Hedge Fund Market Wizards” in 2012. In all his books he interviews professional traders about their trading strategies and their career.
When you read these books, you might notice that most of those professional traders struggled at the beginning of their careers and that most of them lost a lot of money. It took them years of practice, dedication, and hard work to become successful and make consistent profits. While the majority of the traders interviewed by Schwager rely on technical analysis, there are some who use fundamental analysis. There is one thing that we can pick-up from Schwager's book and that is technical analysis is more preferred among traders. There may be some exceptions to it, but if most seasoned traders are using technical analysis then it is without a doubt that there may be something more to this than meets the eye. So let's first start by exploring how technical analysis works and what are the main principles behind it.
What is technical analysis?
In technical analysis, we only look at the current and past price & volume of an asset. For this, we mostly use some sort of chart which displays the price & volume. Based on the chart analysis we then make decisions on when & where to buy or sell the asset (or stay out of the market). Technical analysis focusses on finding repeating patterns in price & volume, recognizing them, and trading them when we see them reoccurring in today's price and volume action. Most trading platforms offer a wide variety of options to perform technical analysis. Examples of these tools are indicators, geometry tools, trend channels, Fibonacci, Elliot Wave, and Gann tools
All these tools have one thing in common. They simply ignore all news and other details about the underlying asset and markets and just use price and volume. Technical analysts believe that the market is not random but moves in cycles and patterns. By recognizing these cycles and patterns they can develop their edge to become successful in trading. One of the biggest advantages of technical analysis is that it enables traders to time their entries and exits. Since all trading decisions are based on specific patterns technical traders are defined as clear rules when and where they will enter the market. This is probably one of the reasons why most professional traders like it. Another advantage is that, because technical analysis ignores all fundamental details about the underlying asset, you can use it to trade any asset. For a technical trader, it does not matter whether he looks at a price chart from Apple or a price chart from Home Depot. They all trade the same! According to other numerous surveys conducted by brokerage firms, on average 70% of traders prefer to use technical analysis over fundamental analysis, and some use both. This can further be verified from Schwager's book, as among all the traders he interviewed, fundamental analysis was only used by about 20% of them.
(example of a chart with some technical analysis)
What is fundamental analysis?
In fundamental analysis, we place a big emphasis on understanding the market conditions. This means having a good understanding of the global markets. For example, a fundamental trader will need to know everything about the recent trade war between the US and China. They will use this information to see which markets might be vulnerable and which might flourish from this and use this to either buy or sell particular stock in particular markets. They will read the reports any unemployment rates, consumer confidence, FOMC reports, financial news statements, read the earning reports, and many more. They try to gather as much information they can find about each asset, market, and global market situation. Because of all this knowledge, most fundamental traders will have a great understanding of the markets and the assets they trade. This allows them to use this information to spot opportunities.
In terms of trading results, all these reports may or may not be a big of a difference. Technical traders will argue that the outcome of the reports is already priced in since most reports are based on at least 2-3 weeks of old data. Then again, we do see huge spikes sometimes during the times these news events are released. Whether or not the reports are useful depends on the trader using them. Clearly some professional traders are doing very well using just fundamental analysis. You may have come across the name Jim Rogers. Jim Rogers had an illustrious trading career and he did not believe in technical analysis at all and solely relied on fundamental analysis. In fact, he was one of the few traders featured in Schwager's book who relied and based his decisions on fundamental data. While the technical analysis may have shown amazing results for a vast majority of the traders, Jim Rogers really believed that it was completely useless. His main reasoning behind this was that technical analysis does not provide you with any valuable information as it doesn't help in predicting asset prices. For many traders out there, the approach Jim Rogers used is rather an eye-opener. He has shown that there is more than one way to succeed in the world of trading, and you do not always have to follow the conventional methods.
One of the main reasons why fundamental analysis is not used by many traders is because it can be difficult for the general public to access get all to all the news. By the time you do get access to the fundamental data, it is already outdated and this significantly affects your overall trading options. Another problem might be the sheer amount of data released. In today's age of we see massive amounts of news released every day about the markets, companies, global markets etc. It will be very hard for an individual trader to keep up with all this news and digest it so he can base his trading decisions on it. Last but not least many professional traders who use technical analysis reason that knowing all this news is useless since its already priced in.
What should I choose?
Now after reading this, you might be wondering which discipline is best for you. Whether you should go for technical analysis or fundamental analysis. Regardless of what you choose, in the end, it all depends on your level of patience and discipline. Market Wizards has shown us that even the best traders in the world had to work hard for years before they became profitable. So, ask yourself if you are up to that. Trading is not for everyone and it can be frustrating. You should accept the fact that you will be losing money, especially during the start of your trading career. Luckily you can practice with a simulator nowadays but still, nothing beats live-trading.
At the end of the day, knowing what's "best" in trading is subjective. There are professional traders on both sides so clearly both types of analysis work. Then there are a lot of traders who use both. They use fundamental analysis to get a broader view of where the market might be heading in the next couple of weeks/months and use technical analysis to make short term trading decisions.
However, beginners are always recommended to start with technical analysis due to the vast number of professionals recommending and using it. Also, most information freely available on the internet will be based on some sort of technical analysis. On the other hand, traders such as Warren Buffet and Jim Rogers have been overwhelmingly successful by adapting fundamental analysis. It can still be a bit difficult to grasp for beginners, but to say that it does not work in trading is certainly a false belief. The more you dive into the world of trading, the more you are going to learn. So, consider it as a never-ending source of knowledge and proceed with the utmost discipline and patience to get the financial gains you are looking for.