Technical analysis vs Fundamental analysis

technical analysis vs fundamental analysis

There are two primary valuation methods for stocks: fundamental analysis and technical analysis.

Technical analysis involves examining prices and volume, while fundamental analysis encompasses the evaluation of all other aspects related to the company or asset. This includes factors such as earnings, dividends, cash flows, taxes, geopolitical stability, industry trends, interest rates, and more.

So, how do you determine which one to use and when to utilize them?

In the past, it was possible to profit by solely relying on either technical analysis or fundamental analysis. However, in today’s highly competitive market, it is essential to utilize all the tools at your disposal to maximize your chances of success.

Example:

Suppose you have the intention of purchasing a house with the objective of holding onto it for 20 years. In such a scenario, what factors would you consider while evaluating the house?

You would likely examine the quality of materials used in its construction, its insulation for winter conditions, the efficiency of the heating system, the condition of the pipes, and any recent infrastructure developments such as highways or malls in proximity. All of these aspects are important because you are aware that they could potentially impact the property’s value over the course of 20 years.

If your objective is to purchase a house and sell it within a week, your evaluation criteria would differ from a long-term investment approach.

In this case, factors such as infrastructure development or the quality of materials may not be your primary concern. Instead, you would focus on the performance of other houses in the neighborhood: their selling prices and the number of houses being sold. Since your intention is to quickly buy and sell, the most crucial information for you would be the current prices and market demand. Understanding the supply and demand dynamics allows you to gauge the immediate marketability of the house.

On the other hand, if your objective is to hold the house for 20 years, the quantity and price of other houses become less significant. Your main concern would be identifying the factors that will impact the property’s value over the long term.

The same principle applies to stocks or any other trading instruments.

Just like the example of buying and selling a house, your evaluation approach will vary based on your investment timeframe.

If your objective is short-term trading, you would focus on factors such as current stock prices, trading volumes, and market trends. These indicators help you assess the immediate supply and demand dynamics and make informed trading decisions.

However, if your goal is long-term investment, you would prioritize different factors. Instead of short-term fluctuations, you would consider fundamental aspects such as the company’s financial health, growth potential, competitive advantage, industry trends, and overall market conditions. By analyzing these factors, you can gain insights into the stock’s potential for long-term value appreciation and make informed decisions aligned with your investment goals.

This is why you will often find that short-term traders tend to rely more on technical analysis, while longer-term traders favor fundamental analysis. A prime example is Warren Buffett, who predominantly utilizes fundamental analysis in his investment approach.

Buffett holds investments for extended periods, allowing ample time for market prices to align with their underlying value. By focusing on the fundamental aspects of a company, such as its financials and long-term prospects, he aims to identify undervalued assets and make informed decisions based on their intrinsic worth.

However, in our approach, we will incorporate both fundamental and technical analysis. Rather than using fundamental reports and statements directly to predict stock prices, we will examine how analysts and portfolio managers utilize fundamental analysis to make their predictions. By understanding their methodologies, we can gauge the potential impact of any changes in fundamentals, such as news, earnings reports, or dividend cuts.

This knowledge allows us to estimate the effect on analysts’ and portfolio managers’ valuations, and consequently, how it might influence the stock price. In this way, we can better anticipate and evaluate the potential changes in stock prices resulting from shifts in fundamental factors.

As short-term traders, specifically day traders or swing traders, our primary focus may not be conducting fundamental analysis. However, we strive to have a solid understanding of it. This enables us to comprehend how changes in fundamental analysis can impact stock prices, which forms the basis of event-based trading. When a significant event occurs or a fundamental ratio undergoes a change, we recognize that it will influence the stock price. By capitalizing on these opportunities, we aim to enter and exit positions to benefit from the resulting price movements.

Conclusion

In summary, our approach involves utilizing both technical and fundamental analysis. Technical analysis involves analyzing charts and patterns, while fundamental analysis involves examining financial statements and underlying company data. We rely on technical analysis for shorter-term trading strategies, while fundamental analysis guides our longer-term investment decisions.

It is common for traders to focus more on technical, while investors tend to prioritize fundamentals when assessing potential investments.

There are individuals who solely rely on technical analysis and dismiss the importance of fundamental analysis. Conversely, there are those who exclusively use fundamental analysis and disregard the value of technical analysis.

In my perspective, both approaches have merit and are valid in their own right. It is essential to develop proficiency in both disciplines. By understanding and utilizing both technical and fundamental analysis, one can gain a comprehensive view of the market and make more informed trading or investment decisions.