All you want to know but never asked about the stocks and options markets.

lunes, 5 de enero de 2015

Technical Analysis vs. Fundamental Analysis

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In financial markets, the key to success is knowing how to predict the future and act accordingly. This means stay long in a position (buy) if you think the market will go up, or close positions or short sell (open a short position) if you think the market will go down. When a trader gets to do this (it is much more difficult than it sounds) will win a lot of money.

To try to know what will be the value of a share or other financial instrument in the future, traders traditionally applied two distinct streams: those who follow technical analysis and those that follow fundamental analysis.

Followers of fundamental analysis state that the value of a stock is the discounted flows of future profits of the company. No more, no less. They try to determine what these future benefits will be, and also try to understand the vicissitudes of the company: news affecting the firm at the stock price, possible corporate moves, strategies, competition, new products ... all the microeconomic information impacts on those future cash flows. They also take into account macroeconomics: how evolves the general business environment, regulatory environment, the political environment ... It is, in short, an approach that seeks to amass information, and turn that information into a series of results and projections for the company that can be deducted to find the updated value of the stock. In this camp we can find experts in macroeconomics, in strategy, business economics, financial ...

Technical analysts are based, however, on the belief that the value of the stock in the future has a high relationship with the past behavior. So, they speak about bullish or bearish trends (these traders mark the trends with lines on price charts), support lines (price levels where it is believed that the stock will stop down and have a "rebound"), resistance lines (price levels where the value of the share will stop rising and a downward bounce can occur), Elliot waves ... here, the profile is much more technical as many investment companies are looking for people able to create complex mathematical models: experts in physics, statistics, econometrics ...

Economic logic says that fundamental analysis is that it makes more sense. However, as an expert from an investment group said not too long ago, "economists are only able to explain things after they occur ... and sometimes not even that." Conversely, technical traders seem to get best results. In fact, as more people believe in technical analysis, it is most likely that its predictions will become real (because people act as if they were real, contributing to its effective realization).

The current trends in the market analysis are, how could it be otherwise, a mixture of the two approaches.  Currently there are increasingly complex mathematical models requiring great technical support, which take into account both the previous behavior of the stock as the changing environment. Nothing, in any case, simple. As anyone could imagine, knowing how much money is at stake.

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