Fundamental Analysis vs Technical Analysis
What are the differences between fundamental analysis vs technical analysis? They’re two schools of thought that investors use to trade in the stock market. Is one better than the other? It largely depends on your investment objectives, philosophy, and time frame. Both can apply to your investment decisions. Let’s find out the key differences between both strategies.
What Is Fundamental Analysis?
Fundamental analysis deals with the intrinsic value of a company.
What does intrinsic value mean? It’s related to all the fundamental and objective factors that can influence the direction of a stock in the long term.
Investors who use fundamental analysis are looking to purchase a stock that has the potential to grow over time.
They want to buy the stock and forget about it until the time comes. What should we look at then before purchasing a stock?
First, how is the economy doing generally? Many factors can determine this in fundamental analysis vs technical analysis.
We can agree that a global pandemic, wars, and meteorological disasters aren’t optimal investing scenarios.
They can last between a few days to a few months and years.
However, they can be good buying opportunities when timed well. Today, tensions between Russia and Ukraine led to global uncertainty and kept the markets on their toes.
We can also take a look at the economy itself. If macroeconomic indicators such as GDP, consumer spending, house prices are growing, it is generally a positive indicator. Another good indicator is low and steady inflation (2%) and unemployment (4-5%).
Fundamental investors try to find the best possible time to buy a stock, at the beginning of an economic recovery, to maximize their gains.
Today’s economy is in a unique situation. The pandemic crippled many nations. Consumer and house prices are quickly rising, but salaries aren’t.
Governments already spent a pretty penny to keep many companies and individuals afloat. All this led to a higher inflation rate. Making sense of all these factors is not an easy task for fundamental investors.
Next in fundamental analysis vs technical analysis, is the industry growing, or has it reached its peak? Analyzing the life cycle of the industry is key.
Certain industries like technology, pharmaceuticals finance, and natural resources have a very long life cycle. They keep evolving and developing to meet our everyday needs. If we anticipate a breakthrough, we should most likely invest in the sector. It is important to choose the best stock in the sector as well. More on that later.
The financial sector may be one of the most steady sectors for investors since its early days. Banks and transaction intermediaries have to stay on top of their game to attract as many consumers as possible.
Blockchain technologies have found their way into the economy. Over the past years, they attempted to disrupt the way money moves in the world. Many investors believe in this market and bought in its early days. Few can predict where it will be in a few years.
Natural resources are also an interesting sector with many ups and downs. We are slowly seeing a worldwide switch to new, cleaner resources. Prices are constantly on the move especially when there is a territorial and global dispute. It is important to keep an eye on the price of various indexes and on companies who mine and innovate with those resources.
Finally in fundamental analysis vs technical analysis, let’s take a look at the company itself. We have to take a look at its global picture. This includes financial statements, management, competition, business concept, potential growth, etc. Digging through all the information available to the public can be a tedious task, but think of your potential earnings.
Fortunately, analysts are paid to publish their findings for us. It is not an excuse to avoid doing our own due diligence. Analysts will publish recommendations on whether the company is overbought, oversold, and their target price. Let’s take a look at Alphabet, or too many, Google (NASDAQ: GOOGL).
Its price is currently under $2,800. Its overall rating is a Strong Buy. Analysts are forecasting the stock in the next 12 months to be anywhere between $3,000 and $3,900.
Many companies and industries are in their early days. They may not have an analyst following their every move. Fundamental investors want to invest in the stock and in the industry before it becomes mainstream.
What Is Technical Analysis?
Technical analysis is widely used by traders. The main goal here is to identify trading opportunities based on patterns.
Traders are looking for an entry and an exit point using different metrics including price and volume.
Past performance is an indicator of future movements. Hence, it is used for shorter-term investments. This method can be used for stocks, currencies, options, commodities, etc.
Many companies and individuals have tried creating the best possible tools in order to predict security fluctuations.
This can be done by gathering as much data as possible and attempting to create models for the future.
Technical analysis isn’t perfect. Many traders can use the same entry and exit points. In order to have any real success, it is necessary to be creative.
Critics of technical analysis base themselves on the Efficient Market Hypothesis (EMH). EMH states that the price of the stock is already reflected by existing information. However, it’s only a hypothesis. Anyone who believes they fully understand how the stock market works are full of themselves.
The following post gives an excellent summary of existing indicators. They can be separated into a few categories. Here are a few.
- Trend indicators: the direction of the market
- Momentum indicators: the strength of a trend and when it will reverse
- Volume indicators: very important to determine a bullish or bearish trend
- Volatility indicators: how often the price of a security changes in a given time period
It’s important traders familiarize themselves with them as they are essential.
Seasoned investors will often use a mix of fundamental and technical analysis to have a deeper knowledge of the company.
For example, fundamental analysis will pinpoint an undervalued stock. Technical analysis will show an entry and an exit point. Each method has its attributes.
Fundamental analysis is used by long-term investors. It attempts to measure the intrinsic value of a company.
That can be done by evaluating the conditions related to the economy, to the industry, and more specifically to the company itself. Investors look at the global picture and at the potential growth.
On the flip side, technical analysis is a tool for short-term traders. It is all about finding an entry and an exit opportunity using various market indicators. The past doesn’t replicate itself, but it is a window into what could happen. Charts, patterns, and trends are the main tools. It is assumed that all the fundamentals are already priced in.
To conclude, whether you are a short-term trader or a long-term investor, doing your due diligence before purchasing a security is essential. The two main schools of thought are fundamental and technical analysis. We shouldn’t limit ourselves to just one. Using all the tools at our disposal will deepen our understanding of a company. This will lead to smarter decisions when purchasing a security.
If you want to learn more about how you can profit from the stock market, head on over to our free library of educational courses. We have something for everyone, including trading options for those with small accounts.