Technical analysis or Fundamental analysis? If you’ve ever tried to learn about investing in the stock markets, you would have probably come across these two terms. But what do they exactly mean? It would take hours and hundreds of examples to fully explain both methods, but I am going to give you a quick 5 minute overview of both methods.
I will cover 3 points. Firstly, a basic overview of the method. Secondly, an in-depth view of the method and lastly, the weakness of the method.
Technical Analysis (TA)
Technical Analysis refers to the reading of charts and using various indicators to evaluate a stock. Analyzing the data gathered from these indicators, you will make a decision about the future direction the price of a stock is headed.
A Basic Overview
- You look at the chart of a stock. There will be indicators on the chart and these indicators have values (Eg 0 to 100)
- The moment an indicator shows a positive reading, it signifies that the stock is going to move upwards. So you immediately buy the stock and wait for the move to happen.
- In addition to indicators, you can also look out for patterns or trend lines that form on the chart. The moment you notice either a positive pattern or a positive trend line(Uptrend) you will buy the stock and get in immediately.
- You get a profit whenever you get a real signal and the stock moves up after you buy it.
An In Depth Look At Technical Analysis
For TA, the focus is on the charts. You are not concerned about the company’s history or the products/services it provides. Your decisions are largely based on the data from the charts and the price movement of the stock.
Your main aim is to take advantage of the price movement of a stock. Getting in early when a stock makes an upwards move with strong momentum. Or shorting a stock if the stock shows intense selling pressure.
The time frame for technical analysis can range from as short as a day, to as long as a few months or a few years. You can set up your investing strategy based on the time frame you prefer.
In Technical Analysis you will use a variety of different tools and indicators. Examples of terms are trends, moving averages, support and resistance or chart patterns. Some examples of indicators are MACD, average true range and stochastics.
If you are keen to learn about Technical Analysis, I have a course here that is suitable for beginners.
The biggest problem with TA is there are no absolute truths. This means the data you get from technical analysis is largely based on an individual’s understanding and point of view. There are no absolute levels or facts in technical analysis.
Two people who are looking at the same chart can draw different conclusions from it using different reasons. It is hard to say anyone is absolutely correct or absolutely wrong. A common saying for this in technical analysis is, “It is more of an Art and not a Science.”
Fundamental Analysis (FA)
Fundamental Analysis is the studying of financial ratios and the products and services of a company to determine it’s worth. You will make your decision after looking at the company’s annual report and evaluating the competitive advantages it may have.
A Basic Overview
- You look at the company’s annual report and get the key financial ratios for the company. Check the products/services provided by the company and determine if the company will continue to grow or be relevant in the next 5 to 10 years.
- You use the key ratios and input it into a calculator. The calculator computes what should be the current price of the company (Eg. $10) You use the current price and compare it with the actual price of the company on the stock market (Eg $8)
- Since $10>$8, the company is currently undervalued according to your calculation, so you buy the stock. If the price of the company on the stock market is more than $10, you wait until it falls to $10 or lower before buying the stock.
- You will recalculate the value of the company once it releases the annual report for next year, and you will repeat the same steps again.
- You get a profit when your calculations are accurate and you pick a company that continues to grow and be relevant in the future years.
An In Depth Look At Fundamental Analysis
For FA, your focus is on the financial numbers and the quality of the companies you are investing in. You will review the annual reports of the company to understand the financial health of the company. From the annual reports you will gain an understanding of the products and services offered by the company.
The main aim of fundamental analysis is to determine a price for the company based on its competitive advantage and future earnings.
The time frame for FA is normally for the long-term as investors will buy a company that they feel is currently undervalued or will potentially experience large growth in the future. Time is needed for the growth or correction in price to take place.
In Fundamental Analysis, you will look at the company’s balance sheet, cash flow and income statements. Examples of terms to look out for are ROE, debt and cash flow. The key figures should be growing from year to year. You will also look at ratios like PE, EPS and PEG.
Some investors will also evaluate a company’s management and the competitive advantages it enjoys over its competitors before using their formula to determine the value of a company.
The biggest problem with FA is, the final value is only as good as the numbers you put in. Because the rates in the calculations are decided by you. So if you use “incorrect” values in your calculation, the final answer you get can be very inaccurate.
A common saying for this in fundamental analysis is, “Garbage in, garbage out.”
So Technical Analysis or Fundamental Analysis?
I use a bit of both TA and FA, with FA making the majority of my strategy because I am investing for the long term and I don’t want to spend a lot of time everyday looking at the charts. I am not a big fan of looking at the charts but I do use TA when I am trying to find a price to enter a stock.
My opinion is that the decision between technical analysis or fundamental analysis is really up to each individual’s preference. Which do you prefer more and which method are you more interested in? Do you have the time and effort for that particular method? There are a lot of personal factors to consider before investing as well.
Anyway, who says you have to pick one? Why can’t you combine them both to get a much more robust strategy? Sure, it’ll be a lot more work but like Warren Buffett once said, “Investing is simple, but not easy.” Learning both Technical analysis and Fundamental analysis will take time but it will give you a stronger foundation in your investments.
Thanks for reading and let me know in the comments if you prefer TA or FA. Or do you have any other better strategy that you use?