When you are interested in investing or index trading, one of many questions you must answer is whether you are interested in fundamental or technical analysis as your trading strategy. These are the two primary investing methodologies, and each system has its own characteristic advantages and disadvantages. The strategy you choose will depend largely on your goals and the current financial markets.

In general, technical analysis is a trading strategy that looks at the past price movements of a particular security in order to predict future price movements. In contrast, fundamental analysis focuses on the fundamentals, which are economic factors directly affecting the company, when making trading decisions.

A Closer Look at Fundamental Analysis

Fundamental analysis looks closely at a business, analyzing its cash flow statement, income statement, and other financial records to determine the intrinsic value for that particular company. When the stock price is below this supposed intrinsic value, the asset is considered a good buy. A stock is considered a poor investment if the purchase price is greater than its intrinsic value. Of course, there are many other economic factors considered by the fundamental analysis trading strategy, but this gives a basic idea of how the analysis works.

Fundamental analysis requires that investors take a long term approach to looking at a company or an asset. Most fundamental analysts want many years’ worth of information from the companies they are considering investing with in order to make a decision. Also, the investments are considered long-term investments, as it takes a while for the company’s actual value in the market to reach its intrinsic value as stated by the analyst. This can result in low returns for the buy and hold investor in a down economy, as assets stagnate instead of increasing in value. The investor is assuming that the increase will come later and that the stock will eventually have the same value as the company’s intrinsic value.

Fundamental analysis has a longer history of use by investors. This has been a tried and true investing method for years. Many financial “experts” tout it as being the most fundamentally sound way to invest money. However, in order to succeed in long-term investing using fundamental analysis, you must have a thorough understanding of economics, the resources necessary to find the economic statistics about a particular company, and a sound company in which to invest. In some cases, investors have lost money when companies that seemed to have solid financials suddenly filed for bankruptcy protection. In the long term, some losses like this may not affect an overall investment plan, but for many seeing them is discouraging in the short term. This has led to a growth in the popularity of technical analysis and index trading.

A Closer Look at Technical Analysis

Those who are interested in swing trading often take the technical analysis approach. This involves analyzing the stock alone and not focusing on the economic factors affecting the company. The technical analyst feels that it does not matter how much intrinsic value a particular company has if that value is not reflected in the stock market, because the value may never be felt by the investor. Everything someone who is index trading using a technical approach needs to know is found in the stock charts.

As such, the technical analysis approach is a more short-term investing style. The goal is not to buy an investment and hold on to it for a long time, but rather to buy an asset when it has a low price and sell it as soon as it has gained enough to make the trade worthwhile. These investors are constantly making trades back and forth, which is why this type of trading is often called swing trading. The charts they use are also short-term in scope. They may cover a few days or a few hours, depending on the type of trading being done, but they rarely cover several years. The goal of the index trading investor is to see what the stock is likely to do in the short term, in order to decide whether or not there will be some increase in the near future.

Technical analysis often produces outsized returns in the short term, as compared to fundamental analysis methods.  Traders using technical analysis need a reliable trading strategy in order to cement their gains over the long term.

When the economy has stagnated, technical analysis can continue to produce significant returns.  When markets as a whole hold steady or drop, there will always be days when a particular stock will do very well, and others when it will do very poorly.  Index trading allows the investor to analyze past trends and predict when these spikes and drops will occur.  This means that the investor can sell when the price jumps up and buy when the price goes down, creating a return even in a time when buy and hold investors are not seeing any.  When trades are done well, nearly every movement in the market earns a return, even if it is just a small one. Fundamental analysis and buy and hold investing styles rely on a company’s performance to generate returns.  If that company’s product or service stops selling well, the investor will lose significant amounts of money.

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Determining which investment style is right for your financial needs is something you alone can do. Are you looking for a long-term investment option, or do you want a short-term option to get you through the current economic downturn without significant losses? Do you need to see an increase in your investment soon for an upcoming expense, or do you have the luxury of time to wait for future increases? A mixed approach utilizing both methods of trading may help balance your portfolio and meet your financial and risk management goals. Regardless, understanding both schools of thought and how they play out in an economic downturn is crucial to your investing success.