Fundamental Analysis v/s Technical Analysis
Fundamental analysis and technical analysis are two distinct approaches used for analyzing financial markets. While fundamental analysis focuses on the core aspects of a business, technical analysis examines market data and patterns. In addition, fundamental analysis considers the financial and economic factors that impact a business.
On the contrary, technical analysis examines the price movements of a stock and utilizes this data to make predictions about its future price movements.
What is Fundamental Analysis?
Fundamental Analysis considers various core factors of a business, including financial statements, economic factors, industry conditions, management processes, and more. Its purpose is to assess the intrinsic value of a firm and determine whether a stock is overpriced or under-priced.
As a result, fundamental analysis is a comprehensive approach that takes into account multiple factors influencing the stock’s price. By conducting fundamental analysis, one can assess whether a stock is priced in line with the overall market conditions.
Fundamental analysis considers both micro and macro-economic factors that affect the stock price. This comprehensive analysis assists in determining the intrinsic value of the stock.
Here are some of the qualitative and quantitative metrics considered in the fundamental analysis:
- Business Model
- Business Cycles
- Customer Base
- Management Competency
- Corporate Governance
- Industry-wide Growth
- Intangible Assets
- Competitive Edge
- Total Profit
- Company’s Annual Revenue
- Accounting Ratios
- Tangible Assets
Apart from the factors mentioned above, various socio-economic factors also contribute to determining the intrinsic value of a stock.
If the intrinsic value of a stock is lower than its current market price, it is considered undervalued. Conversely, if the intrinsic value is higher than the current market price, the stock is considered overvalued.
Consequently, analysts perceive undervalued stocks as favourable investment opportunities with the expectation of higher long-term returns. Conversely, for overvalued stocks, a short position is taken with the anticipation of a future price decline.
What is Technical Analysis?
Technical analysis focuses on the historical price movements of a stock. It utilizes patterns, trends, and past charts to forecast the stock’s future price movements.
Technical analysis relies on data, including historical price movements, trade volumes, and returns, to predict stock prices. Technical analysts assume that all fundamental aspects of the stock are already reflected in the price and remain unchanged.
Furthermore, technical analysis generates buy and sell signals, often referred to as support and resistance levels. These indicators provide guidance on when to enter or exit a trade.
Technical analysis indicates a buying opportunity when the price reaches at support level. They predict that prices will rebound after reaching the support level, leading to an upward movement.
Conversely, if the price of a stock reaches the upper price limit, it suggests a potential decline. Consequently, a technical analyst would consider selling the security based on this indication.
Predicting support and resistance levels requires significant experience and expertise. Incorrect predictions can result in the stock price continuing to rise or fall beyond the expected range, leading to potential losses for the investor.
Momentum indicators such as RSI, MACD, Moving Averages, and others aid in predicting entry and exit prices for a stock. Technical charts, including candlesticks, assist in analysing stock price movements. It’s important to note that the interpretation of candlestick patterns can vary among analysts, making technical analysis a subjective approach.
Furthermore, it’s important to note that technical analysis is primarily used for short-term trading, where predictions are made for shorter timeframes. Investing solely based on technical analysis can carry inherent risks due to the volatility and unpredictability of short-term price movements.
Fundamental Analysis v/s Technical Analysis
Here are the key differences between Fundamental Analysis v/s Technical Analysis:
|Basis of Difference||Fundamental Analysis||Technical Analysis|
|Meaning||Takes into account the core aspects of a business.||Analyses historical stock prices and trade volumes.|
|Purpose||Evaluates the intrinsic value of a stock by analysing factors such as the company’s financial statements, micro and macroeconomic factors, and other relevant data. 2 / 2||Predicts the potential future share price based on historical data, taking into account factors such as stock price movements, trade volumes, returns, and other relevant indicators.|
|Time Horizon||Long term||Short term|
|Relevance||Relevant for long term investing.||Relevant for short term trading.|
|Buy and Sell||Undervalued: Buy the stock Overvalued: Sell the stock||Trend lines, momentum indicators, moving averages, support and resistance levels are utilized to identify optimal entry and exit points for trading positions.|
|Data||Both past and present data are taken for analysis||Only past data considered|
|Indicators||Revenue, expenses, assets, liabilities, financial ratios, other company, industry and socio-economic factors.||Charts, trends and patterns. Moving Averages, EMA, RSI, MACD|
|Impact of External Factors||Un-impacted||Impacted|
|Type of Investors||Long term investors||Traders|
|Concepts||Return on Assets, Return of Equity, etc.||Candlestick patterns, Elliot Waves, Price Action etc.|
|Interpretation||Supported by both qualitative and quantitative factors.||Subjective and can vary among analysts.|
|Methodology||Analyzes industry trends, economic conditions, competitors, and financial data.||Takes into account market psychology in addition to price movements.|
When Should You Use Fundamental and Technical Analysis?
Fundamental and technical analyses cater to different types of investors. Fundamental analysis is well-suited for individuals with a long-term investment perspective. In contrast, technical analysis is more suitable for short-term traders.
Long Term Investing
Compared to short-term trading, long-term investing requires a more comprehensive analytical approach. By analyzing various micro and macro factors, investors can estimate the intrinsic value of a stock. This method enables investors to identify stocks that have the potential for the best long-term returns based on their fundamental values.
Short Term Trading
Technical analysis helps in determining the short-term earning potential of a stock. Stock price predictions based on historical data are typically applicable only for the short term. Consequently, they are not suitable for making long-term investment decisions.
Fundamental analysis and technical analysis are two different approaches to analyzing financial markets. Fundamental analysis focuses on the core aspects of a business to determine intrinsic value, while technical analysis relies on historical price movements and patterns to forecast short-term price movements. Each approach serves different purposes and is suitable for different types of investors. Understanding their differences can help investors make more informed decisions in the financial markets.