There are two main approaches in the world of trading, which, for the most part, are derived from your predetermined goals in the marketplace. If you are looking to invest your money in hopes of a financial return in the form of company dividends being paid out or company share price increase, then you might be considered a long-term investor. On the flip side, if you are looking to make money in the market by trading stocks and securities in an effort to create profits based on the price movement of the stock, then you are approaching the stock market with more of a trader’s mindset. Neither approach is wrong nor is one better than the other; they just have different outcomes based on what you are trying to achieve with your money in the marketplace.
Fundamental Analysis focuses on financial data and the estimated value of a stock based on those available data. The idea being with this approach is a fair market value of a company’s stock can be calculated based on all available information such as company income statements, balance sheets, and cash flow statements. A lot of the time, financial ratios are used to distill the available data quickly into understandable ratios. The core precept being a company’s stock has a calculated baseline worth, which the market should always redirect itself to regardless if the current price is higher or lower than the fair market value of the company in question. Thus, if a company’s price per share calculated to $75, and it is currently trading at $97, the market should eventually come back in line with the calculated share price.
Technical Analysis focuses on the price action of a stock itself and how the current and historical price points can anticipate future price direction and activity. Simply put, historical or past price points of a stock are a reliable indicator of future price behavior. The idea being with this approach is the actual calculated share price of a company carries little weight on the movement of the company’s stock. Granted, it does carry some weight, but the focus with this approach is on the day to day and hour to hour behavior of the stock. After all, the price of a stock is primarily determined by the irrational optimism or pessimism of the individual trader, which lead the trader to buy or sell respectively.
Some of the things a technical trader takes into account when looking for a trade in the open market is to study the price action of a stock by referencing line drawings, moving averages, chart patterns, candlestick patterns, and indicators. We can take a calculated approach where the stock is going by looking at where the stock has been and using various charts and indicators to find support for our belief. Then and only then, if everything lines up with solid confirmation, we can execute a trade.
Thank you for reading and join us next week, where we dive into class 2 of the Foundations of Stocks and Options Level 2.