There are two general approaches to analyze financial markets: Fundamental and technical analysis. Prices on financial market are moving up and down, day by day; and it is very hard to predict the next movement. After reading this article you should understand the core concepts of fundamental and technical analysis and their mutual relationship.
Fundamental Analysis
Let us start with fundamental analysis of a financial market segment. It is quite simple: a fundamental analyst observes the development of supply and demand in the market he follows. He researches the factors could influence the pair. In the oil market, a fundamental analyst would consider events like:
New oil field explorations
Problems like the deepwater horizon oil spill
Movements of oil and gasoline stock levels
Usage of refinery capacity
Development of alternative energies
Overall economic activity
The fundamental analyst tries to connect all these factors into a single picture, and ends up with an opinion whether supply and demand are in an equilibrium, and remain in an equilibrium, or whether there might loom an excess supply, or a demand level way above the available oil. His last step is to evaluate the current market price, asking whether the price will move up, down or remain where it is.
Technical Analysis
The fundamental approach sounds fair enough. But I have seen more than one big company going belly up just a few weeks before the market started to behave according to their forecast. By then it was too late. This is where technical analysis or chart analysis takes over. Technical analysts use information about recent market behavior, like price movements, tends, trading volumes, volatility etc. to get an idea what the market might do next. The picture generated by fundamental analysts may be seen as a glass half full or a glass half empty. A technical analyst tries to figure out, what people might do next. His focus is more on psychology and the mechanics of the trading systems. The technical analyst knows that people can ignore bad news for a long time and then panic suddenly. And he knows that people can be so excited about good news that they hurry into debt and throw every cent they get after a hope which may turn out to be merely hype. Politicians and spin doctors have an interest to influence market perceptions. Technical analysts do not try to forecast the actions of spin doctors, but their charts may signal what impact a PR stunt may have at given point of time.
Facts versus Perceptions
Technical analysts use mathematics and statistics. But in truth they try to measure and forecast market perceptions, attitudes and behavior of people. Fundamental analysts on the other hand try to establish and understand the facts around supply and demand. Fundamental and technical analysis relate to each other like brothers and a sisters. They have a lot in common, but at the same time they are quite different. A fundamental analyst does not always understand or even respect a technical analyst – and vice versa. But you need them both if you want to understand a market make money by trading: A firm grasp of supply and demand conditions, and a thorough understanding of the current market perceptions and sentiment, as evidenced by market behavior and measured by technical analysts.
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