Fundamental vs Technical Analysis & Why Independent Traders focus on Technical Analysis

As promised, here is my answer to the 2nd question:

I know that charts exist, they show developments from the past, possible ones for the future based on experience and a combination of all sorts of figures. But for me, seen from outside and just following the general news on economics and stock exchange values, one has to ‘read’ the future elsewhere. So charts might be a help but what, in my opinion, seems to be much more important is to read the newspapers, know who plans what and when (also in politics) and ‘feel’ in advance what might be decided. If somebody anticipates a decision (let’s say tomorrow China and USA decide to stop all consumption of crude oil and replace by wind and solar energy, even cars will be concerned), you ‘know’ what you have to do, but naturally you must know/feel it before the others.  Or do I see trading as you and your colleagues do it as totally wrong. Is your sort of trading meant differently?

The question touches on what is referred as Fundamental analysis and Technical Analysis.  I hope that the following paragraphs explain what these are, and also why traders like myself tend to place much more emphasis on technical analysis.

Fundamental Analysis vs Technical Analysis

The crude oil illustration is an example of what is referred to as “fundamental analysis” in trading.  It’s the study of factors impacting on the price of a financial instrument – examples: the economic growth of a country impacts its currency value, the alternative energy options impacts the price of existing energy commodities, the new product launch impacts the share price of an individual company, or the level of stockmarket investment allocation by a national pension fund (such as in Japan) impacts the stockmarket index level.  Fundamental analysis can apply in the context of a currency (such as the Euro, or the South African Rand), a stockmarket (such as the Japanese Nikkei 225 index, or the German DAX30 index), a commodity (such as oil or gold) or an individual company (such as Apple, or Vodafone).   Fundamental Analysis often is more relevant for longer time horizons such as weeks, but more commonly months and years.

In contrast, technical analysis is indeed concerned with the study of patterns on price/time graphs.  Looking at past patterns to look whether they could repeat themselves in the future.  This also can be applied for longer time horizons, but just as equally can be applied on lower timeframes – where the time for one candlestick on the graph is as low as 1 minute.  The patterns are more reliable the higher the timeframe.  However the frequency of patterns is obviously much higher on the lower timeframes.

Level playing fields between independent retail traders and large banks

The level of fundamental analysis that can be undertaken varies greatly depending upon the trader or investor. Some banks have employees, whose entire job it is to continuously research 2-3 individual companies – there is no way that a retail trader can have access to the same level of fundamental insight. Likewise when this concerns the research of issues affecting something like crude oil – analysts will research production issues, alternate energy issue, geo-political issues, technology issues and so on.  The example of the possibility of China and USA completely switching to wind and solar energy would fall into this category.   Thus basically there is simply no way that one individual like myself is going to be able to keep up with the sheer amount of resources that larger investors can allocate to research.

The only exception I can think of is where an individual has a close relationship with someone inside a specific company and becomes aware of sensitive information that could impact the stock price of that company – as you probably expect such type of “insider trading” activity is illegal and criminal.  And the possibility of inside information is much lower when the fundamental information concerns an entire stockmarket (rather than just one stock), a commodity or a currency.

As you have probably guessed, the playing field becomes much flatter in the context of technical analysis.  All of the information of the charts is there for every trader and investor to see.  And even retail traders will be able to see about as much as detail as the traders working for a big bank.  The software required to complete real-time analysis is mostly available for free from retail brokerage firms.  I am sure that the bank still have many more “bells and whistles” than the retail traders, but compared to fundamental research, the gap between retail traders and big professional traders is much smaller.

Thus the reason for the technical analysis bias of retail traders is the frequency of trading opportunities, and the better chance of being able to compete with the other players in the market (regardless of size).

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