Technical Analysis vs Fundamental Analysis
The goal of most traders is to buy low and sell high (going long), or selling high and buying back low (going short). If traders could always predict the direction that prices would go, being profitable would be easy. As seasoned traders will tell you...predicting price direction is anything but easy. While being able to always identify highs and lows is near impossible, nonetheless, most traders believe they CAN make highly probable "guesses" using two methods of price prediction: Fundamental Analysis or Technical Analysis.
Traders who rely on Fundamental Analysis predict prices by identifying the geo/political variables that affect price. They then trade when the variables do produce price change. Changes worldwide influence Market prices. New government regulations, weather, environmental conditions, these all affect supply and demand. Wars, economic instability, natural disasters can cause the price of stocks, currencies, commodities, and indexes to fluctuate. Variables like interest rate changes, GDP, and new taxes will also affect prices. These factors are known as fundamentals. Let's say that you trade the stock, IBM. IBM reports its quarterly results and beats its estimates. The value of the stock skyrockets. It's like the old adage..."Buy the rumor, sell the news". Fundamental analysts live for news alerts.
Fundamental analysts generally have adequate financial resources to buy/hold/sell, with the operative word being hold, being able to wait for their investment to appreciate. But traders who want to take advantage of price changes that occur all day long would not be happy waiting for fundmental news reports or interest rate fluctuations that may only happen once a week. These traders are technical analysts.
Technical Analysis is considered forecasting price changes based on an examination of past price changes. Like stock price movements, technical analysis does not result in 100% future predictions. Instead, technical analysis assists investors anticipate "highly probable" price change. Fundamental Analysts use news, interest rate changes, geo/political activity to predict price change. Technical Analysts uses a wide variety of charts that predict price over time.
Technical analysis relies on chart formations and mathematical indicators. There are chart formations that predict a switch in the price's trend, from rising to falling or vice versa. There are other price patterns that suggest price break out of being consolidated (sideways movement). There are even contrarian predictive patterns, where the price was trending and then reverses direction.
Mathematical indicators, such as moving averages and MACD are also used to identify the likelihood of price reversal, or the continuance of the current price movement generating buy and sell signals. The assembly of technical analysis indicators is abundant, continuing to advance as traders develop new chart patterns. Adding to the advancement of technical indicators is the accuracy of computing mathematical indicators rapidly with high speed personal computers. Now, more than ever before, technical analysts can readily predict price changes with neuro networks doing massive calculations, something that was never achievable before.
Perhaps one of the main advantages of technical analysis is its replicability, repeating indicator calculations again and again. So many of the indicators only require historical price and volume. Most indicators are automatically included with live datafeed / charting subscriptions on online trading platforms. Technical analysts who monitor the same instruments day after day, are used to seeing specific chart patterns for their instruments and know what the highly probable price movement will be.
Here are some basic rules for trading with technical analysis
|When the Market is uptrending, as in Bull Markets, go long, buy. In a downtrending Market, as in Bear Markets, go short, sell. Stay with the overall trend. Don't always be a contrarian.|
|Be patient. Trading is a mental game. You'll need to be patient and give the indicators time to develop. Once you see the indicators form the pattern you are looking for, then put the trade on, so you can get the profits you want. With technical analysis, even small profits can result in good profits.|
|Enter when you see strength - Exit when you see weakness. Wait for the indictors to show you there is momentum in the price movement, and thereby strength in the trend. Recognize when the trend has come to an end, be ready to exit. Don't continue to try and "get more". Take what the Market gives you -- Don't make demands on the Market.|
|When entering a trade, make sure you have enough confirmations in your indicators to feel confident in taking the trade. Rule of thumb...at least 3 confirmations before entering a trade. Enter trades that are well thought out. Make your moves, watch for others to make their moves and correct accordingly with a carefully laid out contingency plans for exiting as necessary. Try talking yourself out of the trade and if you can't, then enter. Think of trading as playing chess. See the entire board in front of you. Plan your trades 2 or 3 minutes before you enter, just as you would play chess, thinking 2 or 3 moves ahead|
|Using technical indicators, when spotting minor corrections, prepare to re-enter with the major trend. In Bull Markets, go long after the Market has demonstrated a small pull back at support. In Bear Markets, short after the small pull back at resistance.|
|If the trade turns against you and you can see the chess board change, exit the trade. Small loses are always easier to recover from than large losses. Trading is a mental game. If you sit with a losing trade for a couple of hours, what mental condition will you be in to continue trading.|
|Figure out what trading style works best for you and what trading style you need to stay away from. Say you have more losses shorting, than going long. Then don't short. Go Long. A major mistake most traders make is over-trading. Too many trades in one day. For trading...less is more. Fewer trades that are quality trades are better than just trading and trading and trading.|
|If you have a small loss, take a walk. Walk away from the computer. You need to be cool, calm and collected when trading. Walk away, take a walk around the block. Don't try to make the trade back right away. Know when to quit. Many traders make the money in the morning and give it back in the afternoon.|
|Look for what are known as cookie cutter strategies, trading strategies you feel you can trade every day, specific chart patterns. If you find specific chart formations that you feel you can win with, trade those over and over and over. Trading is a business. The less emotion you put into a trade the better. The more cookie cutter your trading, the better wins you'll have.|
|Think of trading as Star Trek said...resistance is futile. Trade with the Market...the Trend is your friend. To make high probability, consistent trades, trading in the direction of the trend is more likely to be successful than trading against the Market. Trading is all about probabilities. Technical analyis will show you high probability chart formations. Those formations that follow the trend of the Market will more than not, do better than those formations that are going in the opposite direction.|
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