Technical and fundamental analysis are two different ways of studying movements in financial markets. Each type of analysis looks at quotes from different points of view and this determines how traders anticipate the market. However, it is possible to use elements from each of these studies to complement an effective trading strategy, so we will see how to combine technical and fundamental analysis in this article.
Technical analysis vs. fundamental analysis
Before knowing how we can combine technical and fundamental analysis, we must know some of the basic principles of each of these stock market analyses to know how they differ:
This study is based on observing and reading the charts to anticipate market movements by analyzing candlestick patterns, technical indicators of trend, volatility, support and resistance, oscillators, and analytical objects.
Technical analysis has three basic principles
- The price discounts everything: It establishes that the price of an asset is as it should be and that all the factors that could influence it are already included in that price, be they economic, political, social, or of any other nature. In other words, what matters are the consequences of a price change, not its causes.
- Price moves in trends: Whether they are long or short trends, the basic idea of technical analysis is to identify trends in the market and take advantage of them. The trend can be primary for long-term positions, secondary for medium-term positions, and tertiary that includes daily prices.
- History repeats itself: The market has memory, that is, technical analysis is based on behavior and historical data and establishes patterns of price movements based on said data. It is based on the fact that buyers and sellers act similarly when faced with similar stimuli.
For its part, the fundamental analysis considers should analyze the economic, political, and social environment surrounding a quote to determine whether the price is at that moment is balanced with its value, or if instead it is undervalued or overvalued.
This idea completely contradicts the first principle of technical analysis, since it takes into account the causes of a quote more than its consequences. In this analysis, the cornerstone is the Parity Principle, that is, the purchasing power of each currency in a pair must be balanced, and the price difference between them is due to factors such as inflation, trade agreements, political events, company news, etc. So when there is an event that upsets the equilibrium, the market will seek a way to reestablish itself through a counteroffensive, which is taken advantage of by the investor.
How to combine technical and fundamental analysis?
As we can see, technical analysis and fundamental analysis are expressly different from each other, and masters have advantages and disadvantages. For this reason, many traders have chosen to combine elements of technical and fundamental analysis in the same trading strategy, to obtain two types of vision of the market and take into account both the causes and the consequences of a price.
One of the ways to combine these two analyzes in the case of intraday traders and swing traders, for example, is to use technical analysis (reading the charts) to determine the trend and state of a market in a given period, and then use high-impact events on the economic calendar as a premise for a possible change in trend, or a reaffirmation of it.
On the other hand, a position trader could do the opposite: analyze the state of the market through the political, economic, social, and business events that will take place in a given period, and then use technical analysis to determine the ideal entry to the market.
For example, a trader may be facing an uptrend that has a certain deadline, but suddenly news about production losses could change the trend, so it is a good signal to sell.
We have another example in the shares of a certain company: Let’s imagine that the Sony Company has maintained a downward trend, but announces the launch of a new video game console. This news will undoubtedly cause a notable impact on the market, especially if the news is issued around the holidays. In this way, we will use technical analysis to establish market entry and exit, but based on a fundamental event.
There is news that causes prices to move out of the support and resistance areas either due to exaggerated fear reactions or a positive projection. At this point, the analyst expects the news to push the price out of range, establishing new levels of support and resistance, at least while the impact of the news passes.
There is no standard formula for combining technical and fundamental analysis, but finding the balance between these two ways of looking at the markets will give you an interesting vantage point when opening trades and knowing when to close them.
Everything will depend on the asset you are trading with and the world scenario that is developing. It is important to determine how important fundamental events are in establishing their impact on the chart, which in turn will provide information through indicators on potential buy or sell signals. Taking advantage of both technical and fundamental analysis tools will allow you to create a better strategy, which you must have practiced in advance in a demo account of a regulated broker.