Analysis Methods – Fundamental, Technical and Sentiment Analysis
Technical analysis is the study of trading activity using patterns, trends, price movements and volumes. Fundamental analysis is the study of the movement of prices to determine the value of an asset. Sentimental analysis is about feeling the tone of the market through the study of crowd psychology.
Each of these methods of valuing an asset has its merits and none is complete on its own. However, with some types of trading, you will want to rely more on one type of analysis than another in order to better control the risk.
Analysis tools defined
Technical analysis differs from fundamental and sentimental analysis in that it only takes into account the price and volume of an asset.
The basic assumption is that all known fundamentals are factored into the price; thus, they become irrelevant and need not be given special attention.
The technical trader does not try to measure the intrinsic value of the asset, but rather tries to use technical analysis tools such as chart patterns, oscillators and trends to determine what an asset will do in the future. the future.
Fundamental analysis uses macro and micro factors to determine the long and short term value of an asset. Fundamental analysis examines the factors that cannot be measured in a price chart. Some of these factors include supply / demand, economic strength, and economic growth.
Sentimental analysis has often been described as “reading the news”. However, it is probably closer to “reading the price action”. This is because something that reads the headlines can deceive a trader. Therefore, sentiment analysis works best in the short term with technical analysis, but in the long term, fundamental analysis will likely cancel out any sentimental bias in the short term.
Trading with sentimental analysis alone can be effective, but you need to be patient when using this method. News does not come in every day for every asset. If you specialize in currencies, for example, you might only be doing a few trades per week.
How and when to use the three analysis tools
Each trader will have a slightly different way of analyzing the assets they choose, and that’s okay.
Some traders see themselves as pure technical traders and choose to ignore the fundamentals completely. They rely on statistical confidence in trading signals and assume that fundamentals have been factored into their analysis.
Fundamental traders tend to develop a bias in a market based on macroeconomic or long-term fundamentals and then make adjustments to new microeconomic or short-term fundamentals.
Sentimental traders tend to react to headlines and trade momentum based on the news. This implies that a sentimental trader leans towards the technical side since momentum refers to price action.
A sentimental trader is linked to the fundamental side of the equation because the best momentum-generating stock is often caused by a surprise in the news. To be surprised by the news, you have to know the basic expectations before a report, for example.
There is no one way to trade that is better than another. However, when measuring trading risk, technical analysis is probably the best tool to use. Additionally, when building a trading system, technical analysis is probably best due to the plethora of statistical tools available for testing trading theories upfront.
It is difficult to measure the success of fundamental analysis in the short term because it takes a long time for a major fundamental event to develop. Think about the difficulty of trading central bank activity in the short term. Then think about how much easier it is once a central bank decides to ease or tighten its policy.
Sentimental analysis is mainly used by the trader who loves the stock. The sentimental trader often has an indication of what the fundamental report should show and then reacts to whether the report is above or below expectations. Additionally, the trader is likely taking a look at the chart to determine the momentum of the price action. In this case, it is safe to say that the sentimental analysis trader is more likely to use a mix of technical and fundamental analysis.
Many people thrive on trades for the short term, but just as many need to trade for the longer term to be successful. A well-balanced approach will use both timeframes and also use all three types of analysis.
You’ve probably heard the popular phrase that you shouldn’t keep all of your eggs in one basket. This is a fancy way of saying that you shouldn’t rely on just one method for success. This suggests that trading a mixture of technical, fundamental and sentiment analysis may be the best approach with more control over risk.
Trading is high risk, however you think of it, and you will want to reduce that risk for long term success. A little short term trading and a little long term trading will be your best bet for lasting results. Much like mixing a little technical analysis with a little fundamental analysis.
Meanwhile, if you like to trade the stock, then sentimental trading is probably the best, as long as you use technical chart points to control the risk.
This article originally appeared on FX Empire