When deciding which companies to invest in, or how to trade, there are a number of decision criteria one should consider. Analysts tend to fall into two main categories based on how they evaluate a company and make recommendations: technical analysis and fundamental analysis.
Technical analysts use past market data to create a hypothesis on future market movements. The price and volume of shares traded, as well as the market’s volatility are used as key indicators. Technical analysts look to profit from the market by taking into account investor psychology and behavioural analysis when determining a target share/asset price, and when deciding how to trade. Main technical analysis methods include charting and sentimental analysis.
There are three main charts used by technical analysts, including candlestick charts, open-high-low-close charts, and line charts.
- Candlestick charts emphasise the open/close relationship by filling the difference between open and close prices. Red or black “candles” represent a closing price lower than the opening price, while white, green or blue candles represent a closing price above the opening price.
- Open-high-low-close bar charts show the open and close prices by plotting a horizontal line segment, and connecting the two vertically.
- Line charts connect closing prices using a line, revealing the general trend of the company’s share price over time.
When deciding how to trade, analysts look at resistance, support, breakout levels, trends, momentum, ranges, ratios and chart patterns (including, head and shoulders, dead cat bounce, etc.). There are typical market movements that technical analysts have found follow certain trading patterns or indicators. This is based on the belief that history may repeat itself.
Sentiment analysis is the analysis of language and text to determine subjective information. This follows from the belief that investors (and therefore investing behaviour) are influenced by external events, which impact trading behaviour. When deciding how to trade, technical analysts focus on trends. Analysts believe that available information is already reflected in a company’s share price. As a result, new information or a change in sentiment will result in tradable opportunities for CFD traders.
Fundamental analysis, on the other hand, attempts to determine the underlying value of the company based on the company’s assets, liabilities, growth potential etc. Unlike technical analysts, fundamental analysts do not believe the future can be determined by looking at historic information. Rather, fundamental analysts believe trading opportunities are created when a security is mis-priced in the short run. Opportunities for profit exist when investors realise a mis-pricing, and either buy (if undervalued) or sell (if overvalued). Fundamental analysts will consider the company, industry, and economy when making trading decisions.
Both fundamental and technical analysts are aided by the more information available. Therefore, having access to Level I or Level 2 data may influence how to trade, and may have an impact on an investors trading methodology. Level II data reveals the buying and selling pressure of a security. With level 2 data, the highest bid price and the lowest ask price is given, after information from several market makers is aggregated. Thus, it is a better indicator of market sentiment. Level I data, however, reveals only the price, bid and offer, and sometimes basic volume information.