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When looking at investing or trading in shares, combining both technical and fundamental analysis can be a powerful combination. Each of these methods alone has pros and cons.

The problem with technical analysis is that even though it is a good timing tool, it does not help you to select healthy companies.

Alternatively while fundamental analysis can be used to refer healthy companies, it does not help you with timing to get the ideal price.

That’s why using fundamental analysis to select healthy companies and technical analysis as a timing tool can be well utilised if you know what to look for.

Just like investing in property

In a way, it’s a tiny like playing the property market. You can select a great house, on the ideal street, in a fantastic neighbourhood, but unless property prices are going up, the market might not realise the potential of your investment.

Alternatively, if you select a dud of a property when property prices are rising, it could also take into your potential profit from your investment.

Your ideal bet is to select a fantastic property when the property market is also rising to try and increase the likelihood of a return on investment.

It’s the same with share trading. By combining both fundamental and technical analysis, you can get close to seeing a complete picture of your company.

Combining the two styles

Now if you are a trader then technical analysis is likely to be more important to you. But you can also use fundamentals. Why not use technical indicators as your first port of call and then use fundamentals to increase the likelihood of success?

In the same way, if you are an investor, fundamental analysis is probably going to be more important for long-term investments. Why not use fundamental analysis as a first filter and then technical analysis to superior time your investments?

If there is one thing that investors have learnt from the Global Financial Crisis, hopefully it is that timing can be very important. In the same way, a lesson for traders is that fundamentals can't be ignored and the health of an underlying business can be paramount.

What is fundamental analysis?

All in all, share prices aren’t just prices moving up and down, but they are a reflection of a company. If you were interested in buying your local corner shop, you’d look at things such as the management, if profits were improving and if there were competitors taking away market share.

Shares are essentially a share in a business. Fundamental analysis is all about trying to comprehend the underlying business.

The underlying drivers of the business are important. Peter Lynch has this to state to investors:

“Well, they should think about what’s happening. I’m speaking about economics as forecasting the future. If you own auto stocks you ought to be very interested in used automobile prices. If you own aluminium companies you ought to be interested in what’s happened to inventories of aluminium. If your stocks are hotels, you ought to be interested in how many people are building hotels. These are facts.”

Peter Lynch

The point of the story is that investors should be aware of the underlying drivers which help or hinder a business.

In the long-term, share prices are usually a reflection of the value of the underlying business. Companies that are increasing their profits are usually seeing an increase in their business value and share prices will eventually follow suit. You’ll find that businesses that increase their profits, increase their business value and share prices should eventually follow suit.

What is technical analysis?

Technical analysis is about understanding market forces. It analyses price and volume to find out whether there is support for prices, a equilibrise or no support for prices.

The sharemarket is like any marketplace. If there are more buyers than sellers then prices will rise. If there are more sellers than buyers then prices will fall.

Buyers drive up the price and sellers drive down the price.

An example of this is at the seafood markets. Normally prawns sell for around $25 a kilo. But at Christmas, prawns sell for about double. Why the huge difference? The seafood market—like the sharemarket—sees buyers drive up the price and sellers drive down the price. At Christmas, the massive number of buyers drive up the price of prawns. In the same way, technical analysis is the study of prices, but on a much larger scale.

Different ways of looking at the same thing

In the end, no one method can give you the holy grail of profits. But what good traders and investors can do is combine methods to wage a clearer picture of what is happening and how to take advantage of opportunities in the sharemarket.

The truth is that often, fundamental analysis and technical analysis can tell you the same thing. The key is that when they tell you different things, it can be a sign that something is not quite right.

But remember, no matter how you slice and dice the numbers, investing and trading is all about choosing companies that are likely to increase in value for two main reasons:

The underlying business show potential and
Market forces are acting in its favour.

Happy trading!