Fundamental Vs. Technical Analysis: Which is Better?
Two schools of analysis that has been ruling the securities markets are Technical and Fundamental Analysis. While technical analysis considers the price trends of security, Fundamental analysis takes a look at two factors namely the economic as well as financial developments. Both schools help in predicting the future price movements of a particular security. To understand both better and see how to best use these for your benefit, we have summarized the differences and their significances below.
Tools to Trade
Fundamental analysts use the financial statements to start with; technical analysts start the analysis with charts. The overall goal of the fundamental analyst is to evaluate the value of a company by considering its present financial strength depicted through the income statements, balance sheet, cash flow statement, etc. We may also term this as an approach of quantifying the intrinsic value of the company after discounting value of the anticipated projected cash flows to the Net Present Value. A security trading below the intrinsic value offers a better investment opportunity.
Speaking about the technical analysts, their approach is quite different but with the same idea to predict the future possibilities of a particular security. However, instead of analyzing the financial statements they consider the price movements. It is believed that the impact of the statements is reflected in the pricing trends of the security. The price movements are thus analyzed using different charts that hint about the direction in which the price is headed.
The Time Horizon
Usually, the period used by the financial analysts is long term as compared to a shorter period in case of technical analysts. Delimiting stock charts concerning weeks, several days or minutes is possible. On the other hand, fundamental analysts check the data throughout several quarters or even years.
The duration that fundamentally-focussed investors wait before the intrinsic value gets visible in the market is much longer. For instance, the value investors assume that a market has been mispricing the security over the shorter-term, but the price is set to correct itself over the longer-term.
Investors considering fundamental analysis rely on the financial statements released by the company over a quarter along with the EPS which doesn’t change on a periodical basis like the price or volume trends.
It should be noted that a company cannot implement drastic changes overnight and it takes a considerable amount of time for creating new products, marketing campaigns and associated strategies for improving the business scenario. As fundamental analysts use the longer timeframe, the data used for analysing the stock gets generated much slowly as compared to the price and volume data that are used for technical analysis.
Both fundamental and technical analysis has two different goals. The purpose of the technical analyst is to identify the various short to medium term trades that can lead to changes in pricing. On the other hand, fundamental analysts try making long term investments based on the underlying business of a particular stock. The best approach for conceptualizing differences is comparing the scenario to a situation where a person buys a home for immediate needs against a person buying a home for his future.
Critics of Both Types of Analysis
Some critics believe that no substantial basis proves the validity of technical analysis. They keep on questioning the validity of this discipline to a point where they end up mocking the supporters. Usually, Wall Street analyst considers fundamentals but most of the brokerage firms give equal weight to technical analysis. Several professional certifications are being offered for technical analysis wherein some of these have also been included in the CFA examinations.
Among the most popular critics is the one that focuses on the Efficient Market Hypothesis. It states that past trading information is a perfect reflection of the price of a particular stock. Another hypothesis of strong form efficiency believes that both types of analysis are of no use as entire information in the financial market is reflected in the stock’s price.
Although both technical and fundamental analysis is viewed as opposite approaches for analyzing stock prices, investors usually combine both the techniques. An example of this approach is evident from the approach where the investor uses fundamental analysis for identifying a particular undervalued stock in addition to estimating a specific entry and exit price for the present position. In a situation where security is oversold, this combination works well as entering a position early can prove to be costly.
On the contrary, some technical traders often consider fundamentals for supporting their trades. It is possible that a trader is waiting for a breakout around the earnings report and looking at the fundamentals for an idea if a stock is looking to beat its earnings. The idea to mix technical analysis with fundamental analysis is not always well-considered by members of both the groups. However, there are benefits attached to both the schools.