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Understanding the Difference: Fundamental Analysis vs Technical Analysis

By Edited Nov 13, 2013 0 0

A Comparison Approach in Stock Market Investing

Importance and Signficance

Fundamental Analysis and Technical are the 2 main ways that stock market investors and traders generally use in profiting from the stock market, commodities, and futures. Each branch has its own way of analyzing individual stocks so as to come out with a well informed trade. Here’s a closer look between the two types. Fundamental Analysts would always look at the balance sheet, cash flow, and income statements to gauge the true worth of a stock. So if a stock’s price trades below its intrinsic value,  it would be a good decision to buy. In addition, they would also take a look at the economic factors and competition among the rival companies. Usually, they would prefer a company who has a good monopoly of their industry or their product. On the other hand, Technical Analysis makes a wide use of the price action in the charts. This why technical analysts are also called chartists. They study the historical or past price action as well as volume to identify patterns on where the present stock price’s would likely go.  Momentum investing followers like using Technical Analysis because they can see the stock trends. In simple terms, fundamental analysis tell a trader what to buy while technical analysis tells a trader when to buy.

Most notable users of Fundamental Analysis are Benjamin Graham, Warren Buffet and Phil Fisher. They made a lot of money in the stock market and are legends in their own time. There are lots of available books and literature about their investing methodologies in the stock market. Disciples of Technical Analysis would include William ‘O Neil, Gerald Loeb, Nicolas Darvas, Richard Wyckoff, and Jack Dreyfus. Each one of them made their marks in the stock market and are very popular among present day technicians. Their works are still considered as classics in the technical analysis investment field. Generally, the term "traders" is used for technical analysts while the term "investors" is appropriately called on fundamental or value investors.

Fundamental Analysis  as Value Investors

In using Fundamental analysis, one would take a careful look at the profit that a company made as well as the present debt that the company has. Fundamental Analysts would often use ratios like price to book value ratio, price to earnings ratio, and return on equity ratio to get the correct valuation of a company. They would seek out every available important business fundamentals information about the company. They will also try to look at further qualitative data like the competence of the officers of the company, as well as the integrity of the board members of the company. They would also study the different rival companies in the same industry. They would always track the next release of the financial statements to see if the actual data matches their expectations. They would like to see that there is growth in the earnings per share (eps) as compared to the same quarter of the previous year.

Technical Analysts as Chartists

Technical Analysts would always take a look at charts and only charts. All factors are already written in the chart. They would look for the direction of the price. If there is a trend developing, they would trade in the direction of the trend and not against it. They can already see in the charts the support and resistance areas. This gives them the idea where they should buy the stock and where to sell. They use the support level as an opportunity to buy shares of stock and sell these when the stock market price is approaching the resistance level where a lot of traders are also selling their stock shares.

This is why technical analysis is very good for timing the entry into the company stock price. Through the use of a chart, chartists could already see if there are already potential breakouts in the stock price. A breakout supported by high volume would usually continue its price movement for a number of days.

Advantages and Disadvantages: Which is More Appropriate?

So which one is better to use? Fundamental Analysis or Technical Analysis? It would have to depend on each trader or investor’s psychology and time table. If an investor has a time frame of holding to stock for the long term like 2 years or more, it is suggested he go for fundamental analysis. If a trader wants a shorter time frame by just around from a few days or week until 6 months for example, then it is better to use technical analysis.

One also has to take into account the size of the portfolio. Big investment banks, hedge funds, pension firms, and mutual funds invests a large chunk of money. It would take days or even months to fully invest those money. That is why they prefer using fundamental analysis to make sure that even if a company’s stock price drop in price, they know that it will eventually go back to its intrinsic value. Small time traders and investors would be better off in using technical analysis since their small or mid-sized account can make it easier to buy and sell stocks without having to worry about liquidity.

How About Combination of the Two?

A fusion of the best of both worlds is also good. Like a trader can choose the most promising stock with the best fundamentals among his list. He would rank them from those which have a high profit potential from the lesser ranked stocks so as to make a better investment decision. He would take into consideration if he has a margin of safety by comparing its present stock market prices to its inherent intrinsic value. After having a careful evaluation, he would then use technical analysis to get timing signals on when to enter or buy the stock. He would watch the volume very carefully as well as track the overall stock market index so as to limit any probabilities of losses. In this way, he can be assured of a steady increase in gain of his stocks. This is a good way where both fundamental and technical analysis can go supporting each other’s analysis.






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