There are two general approaches to analyze and understand financial markets: Fundamental and technical analysis. Prices on financial market are moving up and down, day by day. 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 appreciate their mutual relationship.

Fundamental Analysis
Let us start with fundamental analysis of a financial market. It is quite simple: a fundamental analyst observes the development of supply and demand in the market he follows and the factors that determine both. If you take as an example the oil market, a fundamental analyst would consider events like:

• New oil field explorations
• Problems like the current deepwater horizon oil spill.
• Movements of oil and gasoline stock levels.
• Usage level of refinery capacity
• Development of alternative energies
• Overall economic activity

The fundamental analyst combines all these factors into a single picture, and will end up with an opinion whether supply and demand are in an equilibrium, and remain in an equilibrium, or whether there will be an excess supply the foreseeable future or excess demand.
As a last step he evaluates the current market price level, asking whether in this example oil is priced fairly.

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 did, what they had forecast. But by then it was already too late. This is where the other mode of analysis comes into play: technical or chart analysis. 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 idea is that it is almost always possible to see the picture generated by fundamental analysis as a glass half full or a glass half empty. A technical analyst tries to figure out, how the market participants in sum react on the fundamental market information. They might ignore bad news for a long time, and then suddenly panic. Or they might become excited about good news, only to discard it a few days later. Policy makers and spin doctors may want to influence the market perception of the fundamentals. Technical analysts do not try to forecast the actions of spin doctors, but the charts may very well give a hint, whether a PR stunt may have a real impact at a given point of time. The main thing to understand: Technical analysts use mathematics and statistics. But in truth they try to measure and forecast market perception of fact on the ground. Fundamental analysts on the other hand try to establish and understand the facts of supply and demand itself.

Use Fundamental and Technical Analysis as a Pair
Considering it all, fundamental and technical analysis relate to each other like a brother and a sister. They are quite different, and the fundamental analyst does not understand or even respect the technical analysts all the time – and vice versa. But to really understand a market and to make money with trading, you need both: a firm grasp of supply and demand conditions, and a thorough understanding of the current market perception of these facts, as evidenced by market behavior and measured by technical analysts.

Be Sociable, Share!

•