Novice or beginning investors soon realize there are different techniques for buying and selling securities. Following a specific technique defines the type of trader you are. Of the many variations, 3 trader types stand out – fundamental, momentum and technical.
Some investors switch from one technique or trader type to another but most settle on one and make it their style. The term “jack of all trades, master of none” comes to mind for those who try to participate in the highly complex stock market wearing different hats. It makes sense, therefore, to pick a trading style and stick to it.
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A fundamental trader is one who focuses on company-specific events to determine which stocks to buy and when to buy them. Fundamental traders tend to be more buy-and-hold traders or investors – not so much interested in short-term trading. There are no hard and fast rules, however, so you will often see fundamental traders buying and selling short term in addition to their long-term strategies.
Fundamental trading relies on fundamental data such as earnings per share, revenue and cash flow. This information is found on a company’s earnings report, cash-flow statement or balance sheet. Fundamental traders use this data to identify trading opportunities, especially if, for example, a company’s earnings are a surprise (positive or negative). Among the most closely watched fundamental factors are earnings announcements and analyst upgrades or downgrades.
As the name implies, momentum traders look for stocks that moving significantly in one direction or the other, try to jump on board and “ride the momentum” to an appropriate place to jump off and capture a profit. In a way momentum trading or investing may seem like taking a knee-jerk response to the market. It involves taking advantage of market volatility by taking short-term positions in stocks that are moving up, selling as they begin downward momentum and then buying other stocks.
Momentum investors tend to be innovators or “first in” investors who take their profit and run to the next opportunity before the stock loses too much value. The rules momentum traders pay the most attention to are selection (of a stock), risk, entry (when to buy), management and exit (when to sell).
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Technical traders surround themselves with charts and graphs, watch lines on stock or index graphs and seek out signs of convergence or divergence that tends to indicate buy and sell signals. Technical trading involves looking back in history, uses recognizable patterns of past trading and tries to predict will happen to stocks in the future.
This is like what meteorologists and economists do in their respective fields. The idea is to learn from history and apply what is learned to make a profit. As everyone knows, however, history is not a perfect indicator of what will happen in the future. Because of this there are hundreds of technical indicators that are used to help fine tune the prediction process. Of those the following are most commonly used - Relative Strength Index (RSI), Trading Ranges, Pattern Analysis, Trend Analysis and Gap Analysis.