technical analysis vs fundamental analysis

Technical Analysis vs. Fundamental Analysis: Key Differences

Investors use two primary analytical skills to determine the value of company stocks: fundamental and technical analysis. The two approaches stand on opposite ends when analyzing stocks.

Technical analysis deals with a stock’s price movements and market volume when selecting and buying or selling a stock. On the other hand, fundamental analysis denotes determining a stock’s intrinsic value by examining primary data like earnings, sales, and performance under various economic situations.

Comparison Chart: Differences Between Technical and Fundamental Analysis

The following chart explains the distinguishing characteristics of the two approaches. Long-term investors tend to use fundamental analysis to evaluate a stock for capital appreciation. Short-term speculators, such as traders, use technical analysis to gauge market opportunities by locating entry or exit times.

Areas

Technical analysis

Fundamental analysis

Methodology

Use and analysis of statistical trading trends of stocks to identify market entry/exit opportunities. Examples are price movements and volume The Study of primary areas’ macroeconomic conditions and a company’s factors like earnings, and other financial factors relevant to performance for identifying a stock’s intrinsic value.

Purposes

Short-term speculating Mid-to-Long-term investing

Features

Prices movements and trading volumes Business models, sales, earnings, and management changes
Data sources Only past data

Past and current information related to a company

Tools for analysis Bars and charts

Micro-economic conditions, industry statistics and company’s past performance

Evaluation processes Discover market entry or exit opportunities through charts and indicator analysis

Identify a stock’s intrinsic value through operating and financial performance and compare with market value to determine the entry or exit price

 

Technical Analysis: Best for Traders

Based on interactions of supply and demand forces in the market, proponents of technical analysis are confident in forecasting a stock’s future price performance. Investors identify a share’s upcoming price trends, like ups or downs, by tracking the data over specific periods in the past.

How does Technical Analysis Work?

Technical analysts think a stock’s price pattern in the market tells when and at what price tag an investor should benefit from buying in or selling a share. The following are frequent tools technical investors use to pinpoint an entry or exit.

  • Market width: The market indicator measures whether primary price trends occur across all industries rather than specific ones. Technical investors discover overall changes in prices through the signals.
  • Time: Investors observe stock price movements through a certain period and find out the change patterns in the market. Examples are year-to-date, one-year, 5-year periods.
  • Price: Another crucial signal is price quotes. Analysts think price changes reflect the ascending or descending orders and convey a buy or sell order to a stock investor.
  • Trade volume: A stock transaction volume over a certain period reflects its market depth. A stock, which undergoes abrupt and profound price changes but records fewer transactions, may not reflect its general price patterns.

A Successful Technical Trader Example

Charles Dow, a creator of the Dow Jones Industrial Index and founder of the Wall Street Journal, is one of the pioneers of technical investing. Categorizing stock market data by averaging daily, weekly and monthly transactions, Mr. Dow correlates the data with the stock market’s ups and downs to track buy/sell signals.

Advantages and Disadvantages of Technical Analysis

Advantages

  • Market trends: Investors grab current pricing trends for their target stocks by acknowledging market sentiments and price trends. The technical analysis aids in making better-informed decisions.
  • Timing: Investors make more accurate entry/exit decisions by analyzing stock pricing movements and trends. A technical price chart expressing a stock’s pricing dots over time gives investors the price patterns and provides a reference to upcoming movements.
  • Stock details: A stock’s price changes and trading volume reflect the market’s attitude towards a stock. Investors can gauge a stock’s receptivity at the market moment and change their investment decision. High price changes and trading volume than others may indicate a buy or sell decision. Lower swings in prices may predict inactive stock movements.

Disadvantages

  • Conflicted analysis: Investors can be bewildered using more than one technical analysis tool to make investment decisions because a chart may produce contrary results from a 50-day or 100-day moving average line. The reason is the tools create output based on various assumptions.
  • Market turbulence: During the 2008 and 2022 market crises, stock prices deviated from traditional predictions used by technical analysts. The tools have limitations in forecasting future stock prices in volatile markets.

financial analysis stock market wondering red shirt guy

Fundamental Analysis: Best for Long-Term Investors

Fundamental analysis aims to identify undervalued or overvalued companies in the market. It uses a measure: intrinsic value. When an intrinsic value is higher than a company’s market value, it is a buying opportunity for the stock. Otherwise, it is a selling time if the intrinsic value is lower than the market price.

A Successful Investor of Fundamental Analysis

Mr. Warren Buffett advocates arguing that a sound business will beat the market in the long term. He has maintained an investment record of an average annual 20% return over the past 50 years and more.

How does Fundamental Analysis Work?

The fundamental analysis is a top-down approach to stock and other financial asset analysis. Factors critical to a company’s success and the economic environment where it exists become essential parts of the analysis. 

The details of the 3-phase approach are as follows:

  • Economic factors: Analysts study political and macroeconomic surroundings for general business operations. Essential factors like interest rate movements, government attitude towards businesses, and inflation all affect a company’s success in its operating environment.
  • Industry: Companies perform differently across industries. The potential for growth for the technology industry differs starkly from that of the real estate industry. Analysts can improve their predictions by understanding industry knowledge like product life cycles, profit margins, and factors affecting an industry.
  • Target to be analyzed: The final phase is a comprehensive examination of a company’s operating models and cost-and-benefit analysis, and financial analysis regarding profit, balance sheet, and cash flow analysis. A thorough understanding helps determine an accurate intrinsic value. 

Advantages and Disadvantages of Fundamental Analysis

Advantages

  • Objective analysis: The analysis requires complex data like earnings, revenue, sales costs, and formulae to examine a company’s fundamentals, such as financial statements. The methodology is prompt to more objective results.
  • Company-specific: The approach requires factors like data from the balance sheets and profit & loss statements, which are specific to the company analyzed. The information reflects the company’s strengths and weaknesses in producing earnings or losses. The analysis is more accurate.
  • Comprehensive coverage: The methodology incorporating macroeconomic and industry trends makes it a more viable and precise model to predict a company’s intrinsic value.

Disadvantages

  • Time and effort: Fundamental analysis requires time and effort in collecting, researching, and analyzing data to yield final results. Investors should put aside resources to do the job before using the method.
  • Biased input: Using most hard data from a company, analysts should still project assumptions like required rate of return, inflation, growth rates, or dividend rates to complete an evaluation process. The assumptions are subjective and can lead to wrong decisions.
  • Short-term fluctuations: Unlike a bar or candle chart, fundamental analysis cannot predict future price movements even though it can pinpoint a real value underlying a stock. A correct model can let you compare the current price of a stock with its real value.

Insights from the Critics

Mr. Warren Buffett, a billionaire and champion of fundamental analysis, believed trying to time the market was a waste of time and dangerous to investment success in the 1994 conference meeting, according to CNBC. He thinks the market is neutral and hazardous to associate it with investments people will make.

The oracle of Omaha elaborates it is foolish to predict the market and not to take action. Mr. Buffett also tells investors to take action if they think the business is attractive. Investors can profit from attractive businesses and should ignore worries about the market.

On the other hand, analysts criticize the theory of “Efficient Market Theory”, where stocks reflect all fundamentals and market factors. All timing is fruitless and unproven because the past will not repeat in the future.

The price pattern model is not reliable, and investors should ignore it. The market ups and downs reflect regular activities of sell and buy orders and have no direct effect on an asset’s current and future prices. Speculators cannot drive up stock prices like the New York Stock Exchange.

Investing Strategies Using Both Theories

Investors take advantage of the 2 approaches to profit in the market. One example is using fundamental analysis to identify an undervalued stock and technical analysis to spot an entry or exit point for a position in the market. However, an investor may suffer losses if a stock keeps falling and he sells the stock for a loss.

Another strategy is to use a company announcement like an earnings report or management changes as a trigger and look for the stock’s pricing lines to profit from a sale or buy position.

Investors may also use advanced investing skills to protect from portfolio loss in market turbulence by buying put options. 

A put option is a right to sell an asset with a specified price agreed upon by a seller and a buyer. The investing strategy allows an investor to protect from losses in market turmoil as he can sell a security at prices to preserve its capital.

See Also: How to Invest in Singapore Stocks and Short Position vs Long Position and S&P 500 Index Fund Review

Bottom Up

Technical analysis uses past price movements and transaction volume to predict future stock prices. In contrast, fundamental analysis focuses on a company’s operating data to find a stock’s intrinsic value. Both approaches examine past data(the fundamental side includes the present data) to predict future prices and flaws because the past is not a guaranteed predictor for the future.

Key Takeaways

  • Technical analysis uses past price movements and charts to determine a buy or sell position.
  • Fundamental analysis emphasizes a company’s operating and financial position, like earnings, to forecast future stock prices by identifying an intrinsic value.
  • Both approaches have drawbacks because the data and assumptions cannot guarantee future stock prices.

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