Fundamental Analysis vs. Technical Analysis
There are two primary schools of thought regarding security analysis – fundamental and technical analysis. Fundamental analysis utilizes a much wider range of information than does technical analysis and relies on traditional financial statement analysis. Technical analysis, on the other hand, concerns itself with attempting to identify patterns in past price movements. Both consider macro economic trends to differing degrees, but emphasize the use of firm specific microeconomic data.
Fundamental analysis generally refers to the study of the economic factors underlying the price movement of securities or commodities, not the price movements themselves. For the most part, this form of analysis usually results in longer-term investments and is considered to be a more conservative approach. At a high level, fundamentalists attempt to quantify the current value of a stock by gathering data relating to general industry outlook, overall market conditions, corporate financial strength, historical patterns of sales, earnings, market share, dividends, etc. Using this data they then try to assign a future value to the stock by interpretation and projection. The difference between the current and future values reflects the fundamentalist’s assessment of the stock’s potential as an investment opportunity. Investment decisions are made based on this fundamental information relative to other opportunities.
Much of the work of the fundamentalist involves accurately projecting earnings going forward and the factors affecting earnings. In theory, the fundamentalist who can make accurate projections and who chooses quality securities when they are under-valued and sells them when they are over-valued can reap substantial profits. Of course, when these assessments are faulty the result is a tendency to maintain a losing position longer than necessary.
Technical analysis is based on the following three principles:
- Everything relevant to the value of a company’s stock is discounted and reflected in share price.
- Trends sometimes appear in share price moves and when once started, these trends tend to persist.
- Activity in the market repeats.
The purpose of technical analysis is to detect the trend or momentum of a stock early so that a good entry or exit point can be selected. Traditionally, charting is the main approach for technical analysis. However, interpreting a chart or an indicator is, at least in part, a subjective issue. Even if you have the knowledge and experience to understand what a chart is telling you, the accuracy is still limited since many trading patterns and some correlative information are not visible or not perceptible directly. The technical analysis generally concentrates on the study of historical price and volume data to detect future trends.
Within the ranks of technical analysis there are two factions – chartists and technicians. While the chartist embraces a more visual approach to the analysis, the technician uses a more quantitative approach and often employs sophisticated statistical methods. Chartists refer to line studies such as trendlines, triangles, speed resistance lines, Gann angles, and the like. Technicians employ technical indicators which usually are variations of common statistical methods such as ordinary least-square regression, exponential moving averages, etc. Whereas fundamental analysis allows you to make an informed determination of a company’s current share valuation, technical analysis aims to improve the timing of your investments.