What are technical and fundamental analysis?
When it comes to trading and investing, market analysis is crucial. If analysis is not done as it should be, all the trades and transactions conducted are merely gambling. That is where technical and fundamental analysis come into play.
Although thorough analysis does not guarantee profits, it definitely goes a long way towards eliminating emotion-based trading decisions. Not only that, it implements a measure of rationality in an ever-volatile market environment.
When it comes to market analysis and forecasting future market trends, there are two major schools of thought, namely technical analysis (TA) and fundamental analysis (FA).
Difference between technical and fundamental analysis
Technical analysis is a way to attempt to predict future market trends based solely on past price movements. Fundamental analysis attempts the same by evaluating the asset on the basis of background information. Both methods are often used concurrently to analyze securities, commodities, stocks, cryptocurrencies and the like.
TECHNICAL AND FUNDAMENTAL ANALYSIS ESSENTIALS
Technical analysis (TA) is a terminological designation for the study of markets, more specifically the changes in market price over a specific period of time. Its objective is to provide a means of forecasting future market movements based on past market trends.
For instance, specific candlestick patterns and chart patterns have a tendency to lead to certain outcomes. There are many technical indicators that can be used in technical analysis, which can provide a better picture of the market trends and aid in predicting future price action.
These indicators include trendlines, moving averages, oscillators, Fibonacci levels and the Ichimoku cloud, among others. Successfully recognizing these patterns and the correct use of indicators is far from easy and requires quite a bit of practice.
Technical analysis gives the impression of being very factual and empirical. Therefore, it is easy to claim that acting in accordance with a specific pattern or technical indicator is guaranteed to be profitable.
However, just like weather forecasts are not to be taken as 100% accurate, market forecasts based on technical analysis should also be considered merely speculations, which may or may not come to fruition.
And while technical analysts are mostly occupied with complex data, numbers and charts, what they are really studying is human emotion and behavior. Every market, crypto included, is driven by people, and people tend to succumb to fear (commonly FOMO) or excitement. And extreme emotions often lead to bad decisions.
Understanding the benefits and limitations of technical analysis can give you a set of skills that will enable you to be a better trader or investor in the long run.
Technical analysis is based on charts that depict the movement of price. The most popular type of TA charts are the so-called candlestick charts, where candle-shaped formations represent fragments of the market with a clear-cut opening, closing, highest and lowest price during the selected time period.
Other types of charts include the open-high-low-close chart (OHLC), which represent the same information as a candlestick chart, albeit in a slightly different visual representation, and the simple and straightforward line chart.
While technical analysis assumes that the price of an asset already reflects all the available information and focuses on the statistical analysis of price movements, fundamental analysis employs a wholly different approach.
The goal of fundamental analysis is to evaluate an asset’s actual value, which can vastly differ from an asset’s current value. It is based on economic, social and political relationships with the asset. Whereas technical analysis can be short or long-term oriented, fundamental analysis is explicitly long-term focused.
Fundamental analysis takes into account the company partnerships of an asset, upcoming news about a certain cryptocurrency, tech innovations and applications (forks, updates, main-nets etc.), social events or meetings of leading world financial institutions to discuss regulations and legal issues. Fundamental analysis also studies the actual demand for an asset.
Therefore, fundamental analysis does not focus on the price and the charts, but it rather studies what events and aspects happening outside of the market could potentially affect the price, either positively or negatively.
However, when trading based on fundamental analysis, a trader should also be well aware of its pitfalls. For instance, certain news could cause the price of an asset to increase. But this does not necessarily mean that this is a good time to invest or start trading as a latecomer.
As market participants are often subject to FOMO (fear of missing out), the price could very well decline after the initial price upsurge. Therefore, on such occasions, one must be cautious so as not to “buy at the top” (buy an asset when the price is just about to start falling).
Utilizing both technical and fundamental analysis comes in handy when trading and investing. The former is helpful for identifying good trade entry and exit points and overall trend strength, while the latter helps to estimate the potential long-term price growth of an asset and determine possible gains.
Despite the fact that certain patterns and indicators point to a specific price direction, and that a piece of news or regulatory changes promise a favorable future for an asset, TA and FA should be taken with a grain of salt, as precise market movement is always cloaked in uncertainty.