Fundamental VS Technical Approaches: Stock Market Analysis
We break down the differences - and which stock market analysis is likely best for you - below.
Fundamental analysis is a method of studying a market, like a stock, based on the context of what's happening in the markets and in the company at large.
This big picture approach seeks to forecast how a share price will move and future stock prices that are likely based on its wider circumstances. The idea here is that, if macro headwinds or tailwinds are likely to affect a certain stock's pricing, fundamental analysts will pick it up.
Also, fundamental analysis may be able to determine a stock's intrinsic value and if the current stock price is either overpriced or underpriced. This also will help with forecasting, as markets tend to correct themselves.
What is fundamental analysis: examples
Different ways of conducting fundamental analysis include studying a company's latest financial results and a history of their earnings. You can look at the company's dividend-paying history and any recent company news released to shareholders or the public about new developments, new product launches and more.
On a more macro level, you can also look at big indices' overall recent performance as a barometer of the overall stock market. Big news like changes to interest rates, major geopolitical news or that country's growth figures may also be taken into account.
Fundamental factors to consider with this analysis
When trying to determine whether or not this type of analysis is right for you, it may be good to ask yourself the following questions:
- How long-term is my approach? Because it looks at macro indicators, fundamental analysis can be more useful in longer-term timeframes and trading styles.
- How good is my understanding of basic accounting and numbers? The backbone of any fundamental analyst's skill set is a deep dive into that stock's company financial statements like their income statement and cash flow statement, plus other figures like debt ratio, earnings per share and more.
Often seen as the opposite of fundamental analysis, technical analysis seeks to forecast price action and how a market (like the stock market for instance) will move. This method may utilise certain tools like studying assets' performance on its chart, plus the use of technical indicators for further confirmation.
What is technical analysis: examples
If a trader wants to predict the movement of the stock market, they may look at the charts of certain indices as bellwethers for the stock market. On that chart, they'll use technical indicators such as oscillators that show potential market direction like the Relative Strength Index (RSI) and the MACD (Moving Average Convergence Divergence), plus overlays that show support and resistance levels like Bollinger Bands.
One of the simplest and most well-known examples is moving averages. Technical analysis users will look at moving average indicators on their charts' present and past data and, if two moving average lines cross each other, it can be a sign to trade on a potential change in market direction. If the Short-term Moving Average (SMA) line crosses from above the Longer-term Moving Average (LMA) to below it, this may be a potential sign that your market may begin to trend downwards. If instead the SMA crosses from below the LMA to above it, it can be a sign that your market may be changing direction to an upward trajectory.
Technical factors to consider with this form of analysis
With trying to determine whether technical analysis is right for you, try asking these questions instead:
- How comfortable am I with the concept of looking at charts several times a day? Because stocks' pricing changes constantly, you'll need to keep a beady eye on charts regularly.
- Similarly, how short-term is my trading style and preferred time frame? Technical indicators on charts will often pick up shorter timeframe trends and price swings, but not necessarily bigger, longer-term shifts.
Strengths and weaknesses
The age-old question: which one is superior, technical analysis or fundamental analysis?
There are pros and cons of each, and how relevant each is to you as a trader will depend on your individual goals and trading plan and your own strengths and weaknesses. But there’s value to be gained from both approaches.
Advantages of a fundamental analysis approach
- Good fundamental analysis will create a far-reaching, 360-degree view of a company's stock price as it's affected by both the wider market and the company's intrinsic value. This creates a solid foundation of knowledge for a trader.
- Because it looks at a company's fundamentals (like its revenue, EBITDA and other performance metrics), fundamental analysis can tell a trader if a stock is maybe overvalued (and overbought) in the current market - which technical analysts often cannot do.
- Perhaps even more compellingly, fundamental analysis can identify those rare opportunities - 'value stocks' which are inherently worthwhile ventures, but for whatever reason are undervalued in the current market. Trading on these can be very profitable if done right.
Disadvantages of a fundamental analysis approach
- Fundamental analysis requires a deep understanding of financial analysis of things like financial statements, income statements and accounting principles, which not every trader possesses and takes time to learn.
- It also looks at company fundamentals, market news and macro trends - all of which are longer-term leading indicators of a stock's price usually. This won't be as helpful to shorter-term trading styles, like scalpers, who want to speculate on price trends in the short term.
- Fundamental analysis often works best with stocks that are more 'predictable' over time - in other words, they're largely financially stable, not very volatile historically and keep to distinguishable trends. These are easier to forecast with fundamental analysis, whereas more erratic and volatile stocks are not. That being said, there is no guarantee of ‘predictable’ behaviour with any share price - and it’s important to remember that past results are not necessarily an indicator of future performance.
Advantages of a technical analysis approach
- Technical analysis is more of a 'science' where fundamental analysis is an 'art' - it involves learning what technical indicators and certain patterns on the charts mean. Technical analysis involves common patterns, and typical expected outcomes of these patterns, in a way that fundamental analysis does not. This may help traders to remove emotion and sentiment from their trading, in order to be more objective.
- The above can also mean that becoming a technical analyst is easier for beginner traders to learn than fundamental analysis, as it doesn't require advanced knowledge of accounting and how financial markets interact on a macro level.
- While we are talking about the stock market in this article, another benefit to learning technical analysis, as opposed to fundamental, is that it works much the same no matter what underlying asset you're trading. So, this method is easily transferable to other markets, like say forex.
- Because technical analysis will usually have black-and-white 'rules' for what to do when certain patterns or numbers emerge on the charts (although these are somewhat open to interpretation) they can be far easier to incorporate into a specific trading strategy.
Disadvantages of a technical analysis approach
- Technical analysis still requires some knowledge - and an incomplete, too-basic understanding of indicators and chart patterns can produce incorrect and/or confusing advice for when to buy or sell.
- With technical analysis, your focus is on the charts, and on the short-term - which can mean you're glued to your screen far more than a fundamental analysis trader is, because the charts change constantly.
- Markets - including the stock market and companies' pricing - are affected by headlines. If you rely purely on technical analysis, without taking into account any news or wider context, you can be blindsided by price swings when news events like earnings season, Nonfarm Payrolls, central bank announcements or other news is announced. That being said, remember the way that markets react to headlines can be unpredictable.
Fundamental vs. Technical Analysis: a comparison
Here’s a useful cheat sheet of some of the biggest differences between the two forms of analyses - and which is best for what, and for whom:
Ultimately, the answer for most traders is that a combination of both technical and fundamental analysis is often best, as each one has distinct strengths that will help in certain situations, and won't help at all in others. Knowing technical analysis will help traders to take advantage of immediate, short-term price swings and remove emotion and sentiment from the picture when trading them. Similarly, knowing fundamental analysis will help hugely going into earnings season, when a solid understanding of company fundamentals like cash flow, future growth prospects and debt-to-equity ratio will help to determine overall price patterns and that share price's longer trajectory.
Yes, most sites and traders phrase it like it's an either/or decision - and yes, it's difficult to learn to be both a fundamental analyst and technical analyst. But properly trading and analysing the stock market is not easy. Still, when done right, it can be immensely rewarding - and potentially profitable, too. However, as with all trading, it’s wise to remember that it’s also possible to make losses and to plan for that possibility accordingly.
Q: What is technical analysis?
Technical analysis is a form of studying and analysing a market, a school of thought which uses that market's price chart and technical indicators only to predict the way that market will move.
Q: What is fundamental analysis?
Fundamental analysis is more broad in nature than technical analysis, and is a method of market analysis which uses the wider context of market 'fundamentals' to predict what it's price will do. With the stock market specifically, that includes company fundamentals and data like revenue figures, cash flow, news and announcements related to the company, the company's debt and growth prospects and more.
Q: Which is one is best - technical analysis or fundamental analysis?
Neither one is better than the other - fundamental and technical analysis are simply different to each other. However, one may be better for you and your specific goals, depending on what they are.
Technical analysis is usually used by traders for shorter-term price movements and to take subjectivity and emotion out of the trading equation by giving simple 'buy here' or 'sell there' instructions to follow.
Fundamental analysis is usually used to predict longer-term trends and to understand the underlying asset more broadly, and the market environment it's in, as a whole. This includes using fundamental analysis to find stocks and other markets which could be considered overpriced and set for a correction or under-priced and could be a good opportunity in future.
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