Merging Fundamental and Technical Analysis

Merging fundamental and technical analysis is by no means a new concept. But it is an important one to which I have devoted some study. Though the underlying assumptions may seem contradictory, I believe these two disciplines are complimentary. Learning to use both methods together has added more depth and perspective to my understanding of the financial markets.

Both methods attempt to analyze an asset, a sector, or an industry to determine what position should be taken, whether long, short, or to avoid altogether. But they differ in their approach.

Fundamental Analysis:

Fundamental analysis looks at a company’s financial condition over time. It is a best-guess estimate of an asset’s current and perhaps future range of fair or intrinsic value, based on financial formulas and assumptions. Analysts study a company’s financial statements, its management, products, industry position, competitors, and customers. They may consider the overall economic climate, supply, demand, and so on.

If we were analyzing the “fundamentals” of an orange, we could measure its color, acidity, vitamin content, and juiciness, estimate supply, demand, weather patterns, and interview growers. We might even taste a few. Using this information, the goal is to determine the price or the fair value of our orange.

Technical Analysis:

Technical analysis looks at the price and volume movement over time. These three elements1 alone indicate value as determined collectively by all market participants analyzing all available data. It is a system of using price, time, and volume data for forth-telling (more so than fore-telling) a security’s perceived value and trend ascribed to it by the actions of all market participants in the aggregate. Is an asset’s price in an uptrend, a downtrend, or perhaps in the midst of a change in direction or speed? The tape tells the tale.

If we were analyzing the “technicals” of our afore-mentioned orange, we couldn’t care less about its acidity, vitamin content, or all the rest of it. The price is in an uptrend and volume is confirming. Whether that is because of anticipated future change in supply, demand, weather conditions, or any other reason, the market has already taken this into consideration.

The markets move over time due in large part to perceived fundamental reasons. Price and volume movements describe the market’s perceptions. One is the study of cause and the other of effect.


The Benefits:

…to fundamental analysts: Adding technical analysis skill can serve as a good check and balance for our fundamental reasoning. Are enough market participants in agreement with our analysis, so as to move the price in our favor? It is hard to profit in the financial markets by being the only person who is “right”. Technical analysis can also serve to provide investment ideas which can then be studied further using fundamentals. Sector and industry charts can help spot newly developing trends useful for tactical adjustments. Technical screens help to narrow the selection process.

…to technical analysts: Adding fundamental analysis skill to our technical repertoire can help explain the validity of our methodology beyond the “it’s uncanny how it works” argument. Because two things appear to have been correlated does not mean that they will continue to be so, or that one is the cause of the other. Without a reasonable economic basis, a technical analyst may become susceptible to the winds of technical doctrine.

So why pick sides or waste time arguing which method is superior? Learn and integrate both technical and fundamental analysis disciplines, and thereby benefit from their synergy.

1. In the case of derivatives, open interest is a fourth element.

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  • By forex robot, July 12, 2010 @ 4:35 pm

    Great site. A lot of useful information here. I’m sending it to some friends!

  • By Bruce, July 18, 2010 @ 9:02 pm

    William O’Neil’s CAN SLIM method, which was developed after extensive analysis of top winning stocks historically, draws the same conclusion. I know this method works from personal experience and from that of other traders. Also, when shorting, take an opposite approach. Take the weaker stocks fundamentally, and use chart setups for shorts for signals.

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