I’m not going to attempt to cover all the different approaches to spread trading here as the would be pretty much impossible. Hundreds of books have been written on this topic outlining all sorts of approaches which you can take to spread trading. Over the coming weeks and months I plan to touch on many of these in my regular blog posts so keep an eye out for them. In the meantime, outlined below is an overview of the two most common approaches traders tend to adopt.
Fundamental Analysis
Fundamental anaylsis is the practice of studying the fundamentals of a business to determine if it is a good investment. It is a way of evaluating the value of a share on the basis of the underlying value of the business. This can involve evaluating key ratios such as P/E (Price Earnings), EPS (Earnings Per Share), looking at the amount of cash on the companies balance sheet and using this to calculate a cash value per share, looking at the companies revenues, profits and growth rates.
Fundamental Analysis
In general those who invest in shares based on fundamentals are taking a longer term view to their investments. They realise that perhaps the market is currently undervaluing a share based on their understanding of the fundamentals of the company and are hoping that overtime the market will realise this and the share price will correct itself.
From a spread trading perspective you can use fundamental anaylsis to find out if a stock is currently undervalued and therefore go long (or buy) the share in question. You could also use fundamental analysis to find out if a share is currently overvalued, which may lead you to short the stock on the basis that when the company’s share price re-adjusts this will result in it falling.
Technical Analysis
Technical Analysis of shares is the complete opposite of fundamental analysis in so far as it completely ignores all data relating to the underlying value of the company in question. Instead technical analysis attempts to predict the future movement or direction of a share based on it’s past performance. Technical analysts are sometimes referred to as chartists.
Over the years the concept of technical analysis has spurned great debate amount professional traders with some (generally those from the fundamental analysis school of thought) saying it is for the birds, is up there with astrology and basically has no bearing on what a share’s price might do in the future.
Technical Analysis
Others however believe strongly in it the concept of technical analysis and many studies, statistical analysis, computer programs written, etc over the years to try determine whether or not it is an impact on share price movements. Whatever your thoughts on it there is no doubt that it plays a huge part in modern day trading and you would be amiss to ignore it completely. Certainly having a grasp of the basics such as moving averages, areas of support and resistance, trend lines and trading volumes is important if you are to become a successful spread trader. I’ll cover many of the key concepts of technical analysis on my blog over the coming weeks and months.
As an aside, this particular spread trader started live very much in the fundamental analysis school, but as time went on and I gained more and more experience trading I have slowly but surely moved towards more of a technical trader. My general approach these days is to try combine the two, I look for stocks which I believe are fundamentally undervalued by the market, and then use technical analysis tools to time my entry into any trade.
