In the world of investing, there are two major techniques that investors, traders, and fund managers (like myself) use in order to forecast future prices of stocks, currencies, and other financial instruments.
They are:
- Fundamental Analysis
- Technical Analysis
In today’s post, you will be learning what they mean, their advantages, differences, and secret tips on how to use them in making smart investment decisions.
Key Things To Note:
- Fundamental and Technical analysis is the most popular and widely used technique of trading and investing
- While fundamental analysis makes use of economic and fundamental drivers and indicators to make investment decisions, technical analysis employs the use of market statistical data to determine future prices, hence, make investment decisions.
- Fundamental analysis is mostly used by those who are looking into long-term investments while technical analysis is used by traders and investors who are looking into short-medium term investments.
What Is Fundamental Analysis?
Fundamental analysis is a method that involves the assessment of the intrinsic value of a stock or currency.
Fundamental analysts and investors who use this method to make investment decisions study the underlying economic and financial factors that affect the strength of the company’s finances.
Investors scrutinize the earnings, assets, debts, and running costs of the company before making any investment decision.
Overall, the goal of a fundamental analyst is to calculate the fundamental value of the company independent of any external factors.
What is Technical Analysis?
Technical analysis is a method of investment that involves the evaluation of stock or currencies based on statistics such as the volume and movements of a particular stock or currency.
Technical analysts believe that price is a mere reflection of fundamentals.
Hence, they do not need to pay close attention to fundamentals but to price action instead.
Fundamental Vs Technical Analysis
In this section, we are going to be using some factors to differentiate between fundamental and technical analysis.
Tool for analysis
Fundamental analysts make use of a company’s balance sheet and financial statements to make their analysis.
Income and cash flow of the stock also come into use by investors in this category when determining the future price of a stock and hence, making investment decisions.
On the other hand, technical analysts make their analyses and decisions through charts and statistical data.
They use trendlines, support and resistance, and momentum indicators among others to view the overall trend of the market, the strengths, and weaknesses of the market.
Time frame
Fundamental analysts often look into data over several quarters and years, while the chart of a technical analyst prints weekly, daily hourly, and even in minutes.
This helps to understand why their investment goals differ.
Investment goals
A typical fundamental analyst sets long-term investment goals while most technical analysts set medium to short-term goals.
Fundamental-based investors review the performance of a stock over the years to be able to envision their long-term goals while investors who make use of technical analysis engage in short-term trades which enable them to buy and sell different stocks within a short period.
Advantages of Fundamental analysis
So, what advantage does this technique offer to investors?
- It provides a more complete picture of a stock: Since fundamental analysis makes use of a wide range of factors to make investment decisions, it tends to provide a more complete and comprehensive view of a stock or currency.
- It can be used for long-term goals: Investors who are looking to make long-term investments in a particular stock would prefer this style of investing since it allows them to locate a stock that has a very convincing growth potential over a long period.
Disadvantages of Fundamental Analysis
Despite the alluring advantages that fundamental analysis provides, it however has some shortcomings. These are;
- Requires a lot of expertise: Given that this style of approach requires a dig deep into economics and macroeconomics, it might not be suitable for investors who are not knowledgeable in this field.
- Unsuitable for short-term investors: Investors who are looking to make short-term investments would not find this approach suitable as it only focuses on long-term investments.
- Slower collation of information: Due to the wide range of information needed to make investment decisions, information gathering takes a longer time.
Advantages of Technical Analysis
Below are some of the advantages technical analysis offers:
- Faster analysis and decision-making process: The technical tools available to investors in this category help them to analyze the market structure faster and hence, enable them to make faster investment decisions.
- It can be used for short-term goals: Technical analysis provides a faster decision-making process which can be used for short-term goals. Hence, suitable for short-term investors.
Disadvantages of Technical Analysis
However fast decision-making this process might offer, technical analysis also has its own faults. These are:
- Riskier investment process: Due to the volatile conditions of the market, this approach of trading might appear riskier since there is no guaranteed method of winning.
- Subjective method of investing: Many investors in this category have different methods of viewing the market which implies that they may not all agree on the future prices of a stock. This might leave some investors confused especially when they are not properly educated in this field.
You can learn more in-depth on technical analysis at The Forex Mastery.
At this point, you should be able to see which of these techniques suits you best.
But that’s not all, another crucial question arises from this which is…
Does Fundamental and Technical Analysis Co-exist?
Well, the simple answer is Yes! They can co-exist and work hand in hand if you know how to use them.
Studies have shown that most profitable traders use both techniques to make smart and profitable investment decisions.
But how exactly do they accomplish this?
This leads us to the next topic which is…
Secret Tips on How To Use Fundamental vs Technical Techniques in Market Analysis.
Here you will learn secret tips on how to analyze the market using both techniques.
Utilise Accessible Tools
Since technical tools provide investors the opportunity to view the overall trend of the market, they can use this method to determine the likely direction of a stock.
These tools also show investors when exactly to buy or sell a stock.
Fundamental analysts on the other hand should look into some financial factors of the company before making investment decisions.
Some of these factors include earnings per share (EPS), price-to-book, return on equity, and projected earnings growth.
Take Into Account the Momentum
Momentum in the financial world simply means how the market price of a stock changes over time.
Investors can utilize technical indicators to determine the momentum of a stock and use fundamental analysis to determine the validity of the momentum and how long it is likely to last.
Do you see how both techniques can be used now?
Conclusion
Fundamental and Technical analysis can be used to make smart investment decisions.
If you want to stick to anyone, just make sure it suits your trading style and approach.
Combining both techniques is not a 100% guarantee for profit but it would increase your chances of profitability.
Lastly, as a newbie, you should choose one of these methods that suits your trading style best and as you gain more experience, you can combine both methods in making your investment decisions.
Learn More: Should You Trade Forex On Thanksgiving Day?
