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1. Fundamental analysis
2. Technical analysis
3. Sentiment analysis
Which Type of Analysis is Best?
Throughout your journey as an aspiring trader you will find strong advocates for each type of analysis. Do not be fooled by these one-sided extremists! One is not better than the other…they are all just different ways to look at the market.
At the end of the day, you should trade based on the type of analysis you are most comfortable and profitable with.
To recap, technical analysis is the study of price movement on the charts while fundamental analysis takes a look at how the country’s economy is doing.
Market sentiment analysis determines whether the market is bullish or bearish on the current or future fundamental outlook.
Fundamental factors shape sentiment, while technical analysis helps us visualize that sentiment and apply a framework for our trades.
Those three work hand-in-hand-in-hand to help you come up with good trade ideas. All the historical price action and economic figures are there – all you have to do is put on your thinking cap and put those analytical skills to the test!
Let me pull out that three-legged stool again just to emphasize the importance of all three types of analysis.
Take out one or two legs of the stool and it’s going to be shaky!
What type of analysis is better ? Whit a different view -
Right, first give you very simple answer, but then explain more. And the answer is as follows – do we really need some other types of analysis, if we have some best of the best? For example, if technical analysis is the best type, why do we still talk about the others?
First, on your trader’s way, you will meet absolutely different, occasionally fantastic traders, who will try to prove to you, that some way of analysis (likely that they use themselves) is a best. You will meet fans as technical analysis as fundamental, may be even other types of analysis that we do not even know (moon cycles). Don’t be confused by these one-sided enthusiasts. As I already have alluded, no one type of analysis is better than the other. They are just a possibility to look at the market from three different points, and you will get 3D-picture, instead of 2-D, or even 1-D (If it’s possible at all!). Although we’ve already discussed, that as a rule, most traders pick some type of analysis as their primary one, because it gives best results or is most suitable for their particular way of trading and secondary types, that trader uses to interpret current situation on the market. See, we need all types together, and here is how it works:
First, on your trader’s way, you will meet absolutely different, occasionally fantastic traders, who will try to prove to you, that some way of analysis (likely that they use themselves) is a best. You will meet fans as technical analysis as fundamental, may be even other types of analysis that we do not even know (moon cycles). Don’t be confused by these one-sided enthusiasts. As I already have alluded, no one type of analysis is better than the other. They are just a possibility to look at the market from three different points, and you will get 3D-picture, instead of 2-D, or even 1-D (If it’s possible at all!). Although we’ve already discussed, that as a rule, most traders pick some type of analysis as their primary one, because it gives best results or is most suitable for their particular way of trading and secondary types, that trader uses to interpret current situation on the market. See, we need all types together, and here is how it works:
Fundamental analysis
It’s unwise to negate the fact that eventually currency rates move due county economic health per se relative to other economies. So, if one economy is healthy and has even stronger perspective and potential, then its currency gains, if not – its currency loses. That is what fundamental analysis stands for. It helps us to make a conclusion about if an economy is healthy at all or not, what perspective does it have, does it grow, flat or recess, is it stronger than another economy, say, EU or not, etc. As a result of the application of fundamental analysis, each trader forms his/her own fundamental outlook as on the current situation as on the future. Let’s go further…
Sentimental analysis
We come to the conclusion that each trader has own fundamental outlook on some country’s economy, say, the US of A. But what does it mean? It means is that each trader has a view how bearish or bullish he/she is on particular economy. The total of these opinions creates a market sentiment. So, fundamental analysis creates shape of assessment by market participants of a US economy, i.e. – total market view (i.e. sentiment) on economy and bullish or bearish sentiment itself.
Technical analysis
As technical analysis is dealing with charts – it allows us to see this current market sentiment both in real-time and as historical and to analyze it with technical tools. In fact, you have all that you need – historical prices, all the necessary figures and data. All you need now is to just study how to apply in-depth analysis as best as you can do and make good trades. You’ve seen what a financial catastrophe will be upon you, if you will rely on just technical analysis and totally ignore fundamental and sentiment.
It’s unwise to negate the fact that eventually currency rates move due county economic health per se relative to other economies. So, if one economy is healthy and has even stronger perspective and potential, then its currency gains, if not – its currency loses. That is what fundamental analysis stands for. It helps us to make a conclusion about if an economy is healthy at all or not, what perspective does it have, does it grow, flat or recess, is it stronger than another economy, say, EU or not, etc. As a result of the application of fundamental analysis, each trader forms his/her own fundamental outlook as on the current situation as on the future. Let’s go further…
Sentimental analysis
We come to the conclusion that each trader has own fundamental outlook on some country’s economy, say, the US of A. But what does it mean? It means is that each trader has a view how bearish or bullish he/she is on particular economy. The total of these opinions creates a market sentiment. So, fundamental analysis creates shape of assessment by market participants of a US economy, i.e. – total market view (i.e. sentiment) on economy and bullish or bearish sentiment itself.
Technical analysis
As technical analysis is dealing with charts – it allows us to see this current market sentiment both in real-time and as historical and to analyze it with technical tools. In fact, you have all that you need – historical prices, all the necessary figures and data. All you need now is to just study how to apply in-depth analysis as best as you can do and make good trades. You’ve seen what a financial catastrophe will be upon you, if you will rely on just technical analysis and totally ignore fundamental and sentiment.
The role of sentiment analysis
Here is another example. Assume that your fundamental analysis shows that economy is growing and on the way to recovery. This assumes that unemployment rate should gradually decrease. Let’s further assume that today is unemployment data release for recent month and you expect unemployment decreasing. You switch on the CNBC channel and a lot of big-headed guys talk about unemployment rate and how important to see it’s decreasing to support the pace of recovery, blah-blah-blah – anyway you’ve got the point - other market participants expect the same, and you just switch the TV off. When the data has been released and unemployment really shows a decrease, you expect to see appreciation of the USD rate and open a trade based on this. Instead of what you expected, you see a strong move against your position. Why, what has happened? Unemployment decreased, the economy grows, what’s wrong, why is everybody selling USD currently? The point is that you totally ignored the sentiment of the market, how bullish or bearish their view on economy. If you have watched CNBC a bit longer that you see that market expectations was for an unemployment reduction of 0.25%, but data that has been released shows a reduction just for 0.1%. It means that the current pace of growth is slower that was expected initially and the USD is overvalued. That’s why it leads to a sell-off of USD on the market. On that simple example you can see, how important Sentiment analysis is.
Here is another example. Assume that your fundamental analysis shows that economy is growing and on the way to recovery. This assumes that unemployment rate should gradually decrease. Let’s further assume that today is unemployment data release for recent month and you expect unemployment decreasing. You switch on the CNBC channel and a lot of big-headed guys talk about unemployment rate and how important to see it’s decreasing to support the pace of recovery, blah-blah-blah – anyway you’ve got the point - other market participants expect the same, and you just switch the TV off. When the data has been released and unemployment really shows a decrease, you expect to see appreciation of the USD rate and open a trade based on this. Instead of what you expected, you see a strong move against your position. Why, what has happened? Unemployment decreased, the economy grows, what’s wrong, why is everybody selling USD currently? The point is that you totally ignored the sentiment of the market, how bullish or bearish their view on economy. If you have watched CNBC a bit longer that you see that market expectations was for an unemployment reduction of 0.25%, but data that has been released shows a reduction just for 0.1%. It means that the current pace of growth is slower that was expected initially and the USD is overvalued. That’s why it leads to a sell-off of USD on the market. On that simple example you can see, how important Sentiment analysis is.
Combination of different types of analysis
Here I want to show you how you can combine all types. For instance you are the trader who trades long-term trends, and fundamental analysis is a particular important one for you. You do a good job and estimate possible long-term trends changing due to changing situation in fundamentals factors of the US economy, you take into account a public sentiment as well, to fairly judge effect of new released macro data.
Say, currently, you see that the economy turns to recovery and shows signs of strength, you see better and better macro data, crowd appetite for positive data (i.e. sentiment) is growing also and you decide to enter on the market based on this – Sell EUR/USD, for instance. But now the question – where to enter, where to place stop/loss order? How can this be done with fundamental analysis? Of cause, you have a possibility just to enter at market without any stops , but in this case you indeed must have ruby wallet to hold any move against you, and this move could be really solid – remember, you trade long-term.
Here is where we come to technical analysis. You can analyze charts and find the area to enter – for example strong resistance level on monthly chart and to place a stop order. Should not rely just on one of them. But here you can see another major task – you have to learn to balance them optimally to get best results. In the nearest time we will dedicate lessons to deeper investigation of technical analysis. First, we will take a look at different chart types, and learn how to read them. Then, we will turn to the classical approach to technical analysis – classical patterns, trend lines, support , resistance and a lot of different indicators. After that we will turn to advanced and more sophisticated part of technical analysis – Fibonacci tools, Elliot wave theory, Gartley’s patterns, pivot points and other stuff.
And only after that will shift to fundamental and sentimental analysis.
Here I want to show you how you can combine all types. For instance you are the trader who trades long-term trends, and fundamental analysis is a particular important one for you. You do a good job and estimate possible long-term trends changing due to changing situation in fundamentals factors of the US economy, you take into account a public sentiment as well, to fairly judge effect of new released macro data.
Say, currently, you see that the economy turns to recovery and shows signs of strength, you see better and better macro data, crowd appetite for positive data (i.e. sentiment) is growing also and you decide to enter on the market based on this – Sell EUR/USD, for instance. But now the question – where to enter, where to place stop/loss order? How can this be done with fundamental analysis? Of cause, you have a possibility just to enter at market without any stops , but in this case you indeed must have ruby wallet to hold any move against you, and this move could be really solid – remember, you trade long-term.
Here is where we come to technical analysis. You can analyze charts and find the area to enter – for example strong resistance level on monthly chart and to place a stop order. Should not rely just on one of them. But here you can see another major task – you have to learn to balance them optimally to get best results. In the nearest time we will dedicate lessons to deeper investigation of technical analysis. First, we will take a look at different chart types, and learn how to read them. Then, we will turn to the classical approach to technical analysis – classical patterns, trend lines, support , resistance and a lot of different indicators. After that we will turn to advanced and more sophisticated part of technical analysis – Fibonacci tools, Elliot wave theory, Gartley’s patterns, pivot points and other stuff.
And only after that will shift to fundamental and sentimental analysis.
What is Technical Analysis :
Technical analysis is a method to analyze the future possible direction of price movement of currency pairs or securities or other financial assets by using past market data, primary price and volume. Technical analysts use charts, indicators and other drawing tools to understand the future possible price movements and its direction. Technical analysis has become very popular for short term, midterm and long term trading. Like other financial markets, technical analysis is widely used in Stock, Commodities and forex markets. Technical analysts develop trading rules and trading systems by using various indicators, theories and charting tools to analyze the Stock, Commodities and forex markets. Technical analysts focus on price actions rather than the fundamental condition of the currency pair. However, technical analysis can be combined with fundamental analysis to obtain a better result.
Basic Assumptions of Technical Analysis:
There are some basic assumptions of technical analysis. These are,
Price discounts everything:
Technical analysts believe that all the relevant information is already reflected in the price. This is why technical analysts tend to understand mass traders’ sentiment on this relevant information which has already reflected in the price of that asset or currency.
Price moves in trends:
Technical analysts believe that price moves in trend. A trend can be uptrend, downtrend or flat. An uptrend means an upward direction of price in a long timeframe. Inversely, a downtrend reflects a long term downward movement of price. Trend is considered as flat or ranging when the market is stuck in range and not moving in any specific direction. In this case, it is considered that there is no trend. Here is an example chart of trends (uptrend, downtrend and flat) given below.
An uptrend can be identified by drawing an upward trend line by joining the higher low points. A downtrend can be identified by finding lower high points or by drawing a downward trend line by joining the lower high points. When the price lies between a horizontal support and resistance lines, then it is considered as a flat trend.
History tends to repeat itself:
This is another basic assumption of technical analysis. Technical analysts believe that history tends to repeat itself in the present and future price movements. This repetition may not be done in exact price or exact time. Usually history repeats itself in forms of chart patterns or situation. These chart patterns and the situation can be found in past, present and future. Some patterns and situations are bullish in nature and responsible for positive price movements. Some chart patterns are bearish in nature and responsible for negative price movements.
Summary:
Technical analysis is not an exact science. So, you cannot win every time you trade with technical analysis, but most of the trades will be winners as technical analysis increases the winning probability. There are different styles and trading methods in technical analysis and traders should choose among these according to their trading personality. Money management and trading psychology play a vital role behind trading success. Using technical analysis without discipline and proper money management will lead you to the losing side in the long run.
Types of qualitative information may include:
Now let's look at some of the disadvantages of fundamental analysis:
What is Fundamental Analysis?
Fundamental Analysis Basics
Fundamental analysis attempts to determine the value of a company by analysing the financial data from the annual report and using other qualitative data about the company and the environment in which they operate. This value is often called 'intrinsic value'.
Fundamental analysis assumes that over the long term, a stock price will reflect the company's intrinsic value.
Definition
A sound fundamental definition comes from Investopedia. They define fundamental analysis as:
A method of evaluating a security that entails attempting to measure its intrinsic value by examining related economic, financial and other qualitative and quantitative factors. Fundamental analysts attempt to study everything that can affect the security's value, including macroeconomic factors (like the overall economy and industry conditions) and company-specific factors (like financial condition and management).
Quantitative analysis
Fundamental factors that are capable of being measured or expressed in numerical terms form the quantitative measures component of fundamental analysis.
Fundamental analysts focus on the underlying business of the company being evaluated and specifically look at quantitative measures such as:
- Revenues
- Earnings
- Assets
- Debts
These financial measures are often combined to produce fundamental or financial ratios that analysts can use to compare the company they are analysing to:
- other companies in the same industry
- the overall market
- previous periods results for the same company.
Ratios that you may be familiar with include:
- Dividend yield
- Price to earnings ratio (PE)
- Return on equity (ROE)
Qualitative analysis
Qualitative information that can’t be expressed in numbers but relates to the nature of the company itself is also very important in assessing the future performance of a company.Types of qualitative information may include:
- management performance and experience
- competitive advantage
- business model
- branding.
Pros & cons
Let's explore the advantages of fundamental analysis:| Objectivity | Uses sound mathematical and statistical principles to produce ratios so that there is no room for personal bias. |
| Long term focus | Markets are usually driven by fundamental factors over the long term. Fundamental analysis can look at long-term economic, demographic, technologic or consumer trends. |
| Value | By determining an intrinsic value, fundamental analysts can determine appropriate buy prices that represent 'good value'. |
| Increased understanding | Research into fundamentals provides the investor with a better understanding of the company and its business. |
| Sleep at night factor | Investors know that they are investing in fundamentally sound companies because they have done their 'due dilgence' analysis. |
Now let's look at some of the disadvantages of fundamental analysis:
| Time consuming | Fundamental analysis can be hard work and be overly complicated. Given the time and difficulty contraints, it may be difficult to get an edge. |
| Market sentiment | In the short term, markets will not always move in the same direction as fundamental value meaning that often short term momentum will overide the fundamentals. |
| Timing | Six monthly issuing of financial information may mean a company's fundamentals have significantly changed and means a time lag for investment decisions. This appplies especially to a lack of opportunity to react quickly to exit stocks. |
| Based on assumptions | Fundamental analysis for future estimated value can only be based on assumptions so a best and worst case valuation model may need to be considered. No valuation model can take into account any unexpected negative economic, political or legislative changes. Another important point to consider is that most information considered in fundamental analysis comes from the company itself and assumptions have to be made that the company is providing accurate and true information. |
What is Sentimental analysis ?
Sentimental analysis is a bit more delicate substance than Technical and Fundamental analysis. Although technical analysis tells us that “price includes all available information” and that price is all trader’s need to make a deal decision – things are not so simple. We will not debate now on does price really reflect all available information or not – let’s assume that it does, but this point doesn’t mean that all traders open positions in the same direction. Of cause every trader sees the direction of the market, but almost everyone has its own explanation why does market move particularly this way.
But take a look at this moment from different side – maybe the market moves in this particular way (up or down), because it just mirrors what all traders think about it. Each trader opens positions according to his or her own thoughts and opinions about the market, and, it fact, all these positions create that substance that we call market sentiment.
Also to point out that sentiment analysis is closely linked with fundamental analysis, because it’s very often that sentiment forms under some fundamental factors affect.
The questions is, "It sounds like talks from another world. What is the practical application of this stuff ?"
The Answer is, " it’s very simple. For example, you are extremely bullish on some currency, say, EUR, but the market has a bearish sentiment – then the market will go down, and you can do nothing here. It’s a pity, but it’s true.
And there is a simple conclusion to us – you can’t for any reason ignore the market sentiment and have to take it into account and include it somehow in your trading strategy. If you will not do that – it will cost you money.
Later we will discuss how to analyze market sentiment so you can use it in your own favor.
And there is a simple conclusion to us – you can’t for any reason ignore the market sentiment and have to take it into account and include it somehow in your trading strategy. If you will not do that – it will cost you money.
Later we will discuss how to analyze market sentiment so you can use it in your own favor.
Fundamental Analysis vs Technical Analysis
Fundamental analysis and technical analysis are two different methods of analysis. There is a major controversy between these two analytical methods. Some think the fundamental analysis more effective than technical analysis. On the other hand some traders think technical analysis is more effective than fundamental analysis. The debate between technical and fundamental analysis is incomplete as it depends on traders or investors choice.
Difference between Fundamental and Technical Analysis:
There are many differences between technical and fundamental analysis. We will discuss about some of the major differences here. These major differences are given below.
Definition:
By definition, fundamental analysis is a method of analysis which measures the value of the currency of a country using economic factors or fundamentals. On the other hand, technical analysis gauges the future possible price movements analyzing the price movements and patterns.
Data sources:
Economic reports and press releases are the required data for fundamental analysis. On the other hand, charts are data sources for technical analysis.
Function:
Fundamental analysis is very useful for long term investment while technical analysis is very popular for short term trading.
Entry decisions:
Investors use fundamental analysis to take investing decisions based on future value of the currency due to the economic changes. Traders, who use technical analysis to take trading decisions, sell higher than his bought price.
Time frame:
Investors enter into a pair for long term (more than a year), while technical analysts hold a pair for short term (not more than 90 days).
Concepts used:
Fundamental analysts focus on the gross domestic product (GDP), retail sales, consumer price index (CPI), industrial production etc. Technical analysts focus on trends, support-resistance, chart patterns etc.
Which one should you use?
Now the question is which one should you follow, fundamental analysis or technical analysis. Both fundamental and technical analysis is effective for Stock, Commodities and forex trading. It depends on you and your personality that which type of analysis is suitable for you. If you are a long term investor then you should focus on the fundamental aspects and if you are a short term trader then technical analysis will fit with you.
Both of these two methods of analysis have advantages and disadvantages, but these two methods can be combined to get better results in Stock, Commodities and forex trading. Every move of the market can be explained by both fundamental and technical analysis. For example, USD/JPY rally of 2012-13 can be explained by both technical and fundamental analysis. Monetary easing were two major reasons for the rise of USD/JPY as JPY got weaker for last one year. This major economic impact leads USD/JPY to a strong bullish trend as per technical analysis. Upward EMA30 showing the long term bullish trend in the daily chart of USD/JPY (given below).
Fundamental analysis can help us to predict the direction of the major price movements. Then, we can confirm the major movement by technical analysis using trend lines, moving averages, breakouts and can also detect buy and sell signals. So, a trader can use fundamental analysis, technical analysis or both in a combination in Stock, Commodities and forex trading. But one should use the method of analysis based on his personality, trading style and expectations.
