Journal of Stock & Forex Trading
Open Access

The Technical and Fundamental Analysis in Building a Trading Strategy

Chao Wu^{* *}Correspondence: Chao Wu, Department of Economic Informatics and Cybernetics, Bucharest University of Economic Studies, Bucharest, Romania, Email:

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Description

A trading strategy is a systematic plan designed to guide decision-making in the buying and selling of financial instruments in various markets. These strategies are built around specific goals, risk tolerance and market conditions and they aim to achieve consistent returns over time while managing risks. A well-constructed trading procedure combines technical analysis, fundamental analysis and risk management techniques to help traders make informed and profitable decisions.

One of the most important components of a trading strategy is technical analysis, which involves studying historical price movements and market data to forecast future price trends. Traders who rely on technical analysis often use charts, indicators and patterns to predict the direction of asset prices. For example, they might look at price patterns like head and shoulders, double tops or flags, as well as technical indicators such as moving averages, Relative Strength Index (RSI) and bollinger bands. These tools help traders identify trends, potential entry and exit points and price levels where reversals or breakouts might occur.

Another key aspect of trading strategy is fundamental analysis, which involves evaluating the underlying factors that might influence the value of an asset. This type of analysis is commonly used in longer-term strategies, especially in the stock market, where traders or investors assess a company’s financial health, industry position, economic conditions and other relevant data to determine whether an asset is undervalued or overvalued. For example, a trader may focus on earnings reports, market news or macroeconomic indicators such as interest rates or inflation to inform their trading decisions.

Trend-following strategies are one of the most common approaches used by traders. The idea behind trend-following is simple: to buy an asset when its price is trending upward (bullish trend) and sell when the price is trending downward (bearish trend). Traders following this strategy rely on technical indicators such as moving averages or trendlines to confirm the direction of the market and enter trades in the same direction as the trend. The goal is to capitalize on the momentum of the trend and hold the position until signs of a reversal or weakening momentum appear.

On the other hand, mean-reversion strategies are based on the premise that prices tend to revert to their historical average over time. In this type of strategy, traders look for assets that have deviated significantly from their historical price range and place trades expecting the price to return to the mean. For example, a trader may buy a stock if its price has dropped too far below its moving average, anticipating that the price will rebound to a more typical level. Conversely, if the price rises above its historical average, the trader may sell, expecting the price to decline.

Another procedure that has gained popularity is scalping, a short-term trading strategy that involves making rapid trades to take advantage of small price movements. Scalpers aim to profit from quick, small price changes and typically hold positions for just a few seconds to a few minutes. This strategy requires a deep interpretation of market liquidity and the ability to make quick decisions, as well as access to fast trading platforms and low transaction costs. Scalping is high-frequency and highly active, with traders making many trades in a single day.

Swing trading is another short to medium term strategy that seeks to capture price movements within a trend over several days or weeks. Swing traders typically look for assets that have established a trend and attempt to profit from price "swings" that occur within that trend. They enter trades based on technical indicators, such as support and resistance levels, candlestick patterns or momentum indicators. Swing trading can be less stressful than day trading because positions are held for longer periods, allowing traders to capture larger price movements.

Risk management is an important element of any successful trading strategy. A key part of risk management involves setting stop-loss orders, which automatically close a position if the price reaches a certain threshold, limiting potential losses. Traders also use position sizing, determining how much capital to allocate to each trade based on their risk tolerance and account size. The goal is to ensure that no single trade or series of trades can lead to excessive losses that could harm the trader's overall capital.