By Craig Erlam
In the 1930s, the economist John Maynard Keynes famously said: “markets can stay irrational longer than you can stay solvent.” In other words, it is nearly impossible to predict the markets – and those who try may find themselves in over their head.
I’ve seen this maxim proven right thousands of times – but that doesn’t mean there isn’t value in research. There are huge benefits to be gained from applying the two main approaches to investing in the financial markets: fundamental and technical analysis.
The art and science of fundamental analysis
Fundamental analysis involves assessing the intrinsic value of an asset based on various factors, including financial statements, economic indicators, industry trends, and company-specific information. If an investor believes an asset is undervalued based on their analysis, they may decide to invest.
Fundamental analysis is often used for long-term investment strategies, as it considers factors that may impact an asset’s value over an extended period. This is particularly useful for stocks, where it can help identify undervalued companies or industries poised for growth, or currencies, when determining a currency’s value.
Technical analysis – the astrology of investing?
Technical analysis, on the other hand, focuses on analysing historical price and volume data to identify patterns and trends. It assumes that all known information is already reflected in the market price, and the key is to use this information to interpret how prices may respond in the future.
Traders using this approach may aim to profit from short-term price fluctuations and capitalise on trends that emerge from market psychology. For that reason, critics call it the “astrology of investing”. But although it can be an inexact science, it can also be extremely valuable. When a company announces results or an economic report like the US jobs data is released, for example, it is not always immediately clear whether they are good, bad, or something in between. But technical analysis can often quickly offer valuable insight into what investors think of it as a collective. That doesn’t mean the initial reaction will always be sustained but there is value in it nonetheless.
Finding comfort in both worlds
Neither method is foolproof. For this reason, some investors prefer to adopt a hybrid approach, combining elements of both methods to give them extra conviction in trading decisions. For example, an investor may use fundamental analysis to form an opinion on a company’s long-term prospects and then use technical analysis to identify opportune entry or exit points based on price trends or indicators.
But those who favour a hybrid approach can fall victim to confirmation bias if they let their fundamental beliefs cloud their interpretation of technical signals, or vice versa. One way to mitigate this bias is by covering up the name of the instrument being analysed during technical analysis to ensure an objective assessment of the chart. This helps traders make more informed decisions based on technical market signals rather than preconceived ideas.
Carving a reliable path forward
The choice between these two approaches often boils down to personal preference – traders and investors are drawn to the method that resonates with their investment style and personality, while others find value in a hybrid approach.
It’s impossible to predict the markets with absolute certainty. The art of investing lies in finding a balance between carrying out rational analysis and recognising the irrationality of market behaviour. By finding the approach that works for them, investors can gain valuable insights into the underlying factors driving asset prices and market trends.
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