There are three broad ways to approach a market: fundamental analysis, technical analysis, and order flow. This article covers the first two and where order flow sits in relation to them. For order flow itself, see Basic Concepts.
Fundamental Market Analysis
Fundamental analysis measures the value of an asset by studying the financial and economic factors around it.
A trader doing fundamental analysis looks at macroeconomic factors such as the economic environment and interest rates, and microeconomic factors such as the profitability of a business or the strength of its competitors.
The goal is to work out whether an asset is trading at a fair price, or whether it is under- or overvalued. An undervalued asset, trading below what is considered fair market value, is treated as a buying opportunity on the assumption that price will rise to meet or exceed that value.
Fundamental analysis can make sound predictions over the long term while being completely wrong about the next hour. If you trade short-term movements, it is not the tool to lean on.
Technical Market Analysis
Technical analysis works the other way around. Rather than economic factors, it looks at statistical trends produced by trading itself, mainly price movement and volume.
It applies to any market with historical data, including stocks, futures and cryptocurrencies, and it is especially common where traders focus on short-term price movement.
The core idea is that past price changes and trading activity contain useful information about future price movement. Used as part of a plan that includes risk management, technical analysis can be an effective way to trade. It is worth noting that while some traders use technical analysis on its own, experienced traders usually combine several forms of analysis.
Traders use technical analysis mainly to examine price, but it also extends to other data such as volume and open interest. Over the years a large number of indicators have been built, which broadly fall into these categories:
- Price trends
- Chart patterns
- Volume indicators
- Momentum indicators
- Support and resistance levels
The Guiding Principles
Charles Dow made two assumptions about technical analysis that still frame it today: that a market is efficient and the value of an asset reflects the variables affecting its price, and that price movements form repeatable patterns and trends even when they look random.
Later work expanded on this, and three assumptions are now widely accepted:
- An asset’s price already reflects every factor that might affect it, including market sentiment. What is left to analyze is the price movement itself, which is the result of supply and demand.
- However random price movement looks, it still forms trends on any time frame. Most technical strategies assume price is more likely to continue a historical trend than to move unpredictably.
- History repeats itself, largely because of market psychology. Chart patterns are read as an attempt to work out what participants are feeling and how those emotions move price.
Limitations of Technical Analysis
Some argue that historical data cannot produce actionable insight, and that this makes technical analysis ineffective. By the same logic, fundamental analysis would be ineffective too, since it also works from historical data.
A second objection is that history repeats itself only approximately, never exactly, which makes studying price patterns unreliable.
A third is that technical analysis is partly a self-fulfilling prophecy. Many traders use the same indicators and similar strategies, so when their setups show price hitting support, they buy, and the buying itself pushes price up.
Every form of analysis has limitations, which is why most experienced traders combine them rather than committing to one.
Where Order Flow Fits
Fundamental analysis asks what an asset is worth. Technical analysis asks what price has tended to do at a given level. Order flow asks what is being bought and sold right now.
The three answer different questions and work best together. A technical level tells you where to pay attention; order flow tells you whether that level is being defended or given up while you watch it.
Order flow is covered in Basic Concepts, and the rest of this manual covers the tools Exocharts gives you to read it.