Fundamental vs. technical analysis

Every trade starts with an opinion about where price is going. CME Group’s education course sorts the evidence traders use into two broad families: fundamental analysis and technical analysis. This lesson explains what each one looks at, the vocabulary that goes with it, and how the two fit together.

Fundamental analysis: why price should move

The CFTC glossary defines fundamental analysis as the study of the basic, underlying factors that will affect the supply and demand of the commodity behind a futures contract.

A fundamental analyst asks questions like these:

• Is supply rising or falling? CME’s example is a trader who reads a crude oil inventories report, decides supply is likely to fall, and buys crude oil futures expecting a higher price.
• What could shock supply? Natural disasters, supply chain problems, and product defects can change supply suddenly. CME describes a damaged oil port that stops tankers from unloading, cutting supply in a way no model predicted.
• What does it cost to produce? Oil wells have different extraction costs. CME notes that when price rises enough, higher-cost wells can be switched back on, which adds supply and can push price back down.
• What drives the underlying value? For a stock index future like the E-mini S&P 500, CME points to expected future earnings of the companies in the index.
• How are markets linked? If livestock feed gets expensive, the cost of raising each animal rises. CME’s example: farmers may sell off herds in the short term (pushing prices down), which reduces future supply and can push prices up later.

Calendars matter too. The CFTC glossary defines a crop year as the period from one harvest to the next, which varies by commodity: July 1 to June 30 for wheat and September 1 to August 31 for soybeans.

Technical analysis: what price is doing

The CFTC glossary defines technical analysis as forecasting prices by examining patterns of price change, rates of change, and changes in trading volume and open interest, without regard to the underlying fundamental factors. A chartist is a technical trader who reacts to signals from price charts, and charting means plotting price trends, average price movements, volume, and open interest.

Three of those inputs come up again and again:

• Price, drawn as a chart over time.
• Volume: the number of contracts traded during a specified period (CFTC).
• Open interest: the total number of contracts entered into and not yet closed by an offsetting trade or by delivery (CFTC).

Core chart vocabulary

Support. A price area where new buying is likely to come in and stem a decline (CFTC). CME describes support as levels generally below the current price.

Resistance. A price area where new selling will emerge to dampen a rise (CFTC). It generally sits above the current price.

Role reversal. CME’s support and resistance lesson explains that when price breaks through support, that level tends to act as resistance when price comes back up, and broken resistance tends to act as support.

Trend lines. In a rising market, a trend line is drawn through a series of lows in price, giving an upward sloping line that may act as support. A line through the highs as well creates a channel. The same lines can be drawn in a falling market (CME).

Moving averages. Traders plot averages of different lengths. CME says a moving average below price can act as support and one above price as resistance, and that shorter averages generally give weaker support or resistance than longer ones.

Congestion. In technical analysis, a period of repetitious and limited price fluctuations (CFTC). Think of price going sideways in a narrow band.

Head and shoulders. A chart formation shaped like a head between two shoulders, generally considered to predict a price reversal (CFTC).

CME adds an important caution: support and resistance will not always hold to the exact price. They are zones, not exact prices.

A worked example (made-up numbers)

Imagine a made-up commodity, used only for illustration.

• The technical view: price has risen to 100 three times and fallen back each time. A technical analyst calls 100 resistance. If price finally breaks above 100 and later dips back toward it, the analyst expects 100 to act as support (role reversal).
• The fundamental view: the same market is studied for supply. Suppose many producers become profitable at a price near 100. A fundamental analyst expects more supply to appear near that price, which could explain why rallies keep stalling there.

Two different methods, one price level. CME uses a very similar crude oil example to show how the views can point to the same place for different reasons.

Using both together

CME notes that traders often combine the two. Some build a supply and demand model first and then use charts to confirm it or fine-tune entries and exits. Others start with charts and then check whether the fundamentals are strong enough to push price through support or resistance.

One more idea from the CFTC glossary is worth knowing: technical analysis can work consistently only if the theory that price movements are a random walk is wrong. In other words, chart reading assumes past price behavior carries some information about the future.

Key ideas

• Fundamental analysis studies the supply and demand factors behind a commodity: inventories, shocks, production costs, earnings, linked markets, and crop years.
• Technical analysis studies price patterns, rates of change, volume, and open interest, without regard to fundamentals.
• Support stems declines (new buying); resistance dampens rises (new selling). Once broken, each tends to switch roles.
• Trend lines, moving averages, congestion, and head and shoulders formations are core chart vocabulary.
• Support and resistance are zones, not exact prices, and many traders combine both approaches.