While on a long journey to reach a destination there are always multiple paths.
Even if it’s a shortcut the effort taken is equal to that of a long cut route.
In the same way to understand the behaviour of a particular stock, analysts/investors take aid of such different forms of analysis.
Fundamental and technical analysis are the two different routes of the destination called trying to ‘Understand the asset’.
These analyses help investors to make an informed investment decision timely.
They help investors to take action whatever and whenever necessary.
It could be buying, selling or holding an asset which could be a commodity, stock or any type of asset which is traded in a market.
Both the approaches are poles apart from each other in terms of assumptions and applications.
Some feel comfortable following technical analysis while some keep themselves updates with the fundamental aspects.
Let us discuss each of these below;
Fundamental Analysis
Fundamental analysis is the discipline of stock selection based on economy, industry and company fundamentals.
This approach is also known as the top-down approach.
One distinguishing feature of this approach is that an investor is able to identify the intrinsic value or true worth of a share.
Accordingly, the main principle of the approach states that “If the current market price of the asset is less than the intrinsic value or true worth, one should buy the same and vice versa.”
Another interesting element which also acts like a trap for investors is that, assumptions of fundamental analysis that the price in the stock market does not fully reflect a share’s real value owing to information asymmetry.
To become a fundamental analyst:
one needs to have good understanding of basic economics
understand the businesses model especially with respect to the industry in which it operates
understand the basic financial statements especially how the cash flow is generated for the business and other allied aspects.
Most importantly a Fundamental Analyst has to be updated with the above information on a regular basis.
Technical analysis
Technical Analysis is a completely separate branch of study which in other words is exactly to the opposite pole to fundamental analysis.
It assumes and operates on a simple principle that price discounts everything.
It means that all of the factors considered by a fundamental analyst are reflected in the price of a financial instrument through buying and selling activity, where holding patterns gets isolated.
Accordingly, supply and demand determine prices; changes in supply and demand cause changes in prices; prices can be projected with charts and other technical tools.
This field of study uses the data generated from the market such as price, volume, etc., which is graphically displayed, in decision-making.
Diving back to history, the first recorded use of technical analysis was in Japan in the 1700s, where it was used to analyse trading in the rice market.
Though this is the oldest tool being used by the Japanese, these tools were translated and widely understood outside Japan only in the 1980s.
Which one is best?
Technical analysis approach is driven solely by price and volume data generated from the market.
But the fundamental equity approach arrives at the intrinsic value differently.
It predicts security price movements, by analysing various economic, industry and company data and incorporates data that are external to the market.
A key distinction features between technical analysis and fundamental analysis are purpose, usage and action signals.
Technical Analysis revolves around determining security or the market’s prospective patterns by analysing historical price movements and volumes of trade. Whereas , Fundamental Analysis is about understanding a security’s fundamentals via its financial performance, management, and overall market conditions.
Investors typically use Technical Analysis for short term trading and the later is predominantly utilised for long-term investment.
There is an ocean of technical tools used in Technical, among them: Support and resistance, moving averages, trend lines, and momentum-based indicators are popularly used once to determine the call of action to buy, sell or hold the asset. In Fundamental Analysis the game revolves around overvalued and undervalued assets.
At this juncture one can definitely say that technical analysis uses more concrete and actual data whereas fundamental analysis is more theoretical because it seeks to determine the underlying long-term value of a security.
The financial statements analysis under fundamental analysis are not objective data but are the result of numerous estimates and assumptions that have been added together to arrive at conclusions in the financial statements.
Technical analysis can be considered to be more practical because it studies the markets and financial instruments as they exist, even if trading activity appears, at times, to be irrational.
To conclude, fundamental and technical analysis are both useful and valid, but they approach the market in different ways.
You can use any one of the above or both as long as you are making money.
