Fundamental analysis and technical analysis are two different mechanisms that help in analysing the financial markets. Fundamental analysis, as the name suggests, looks at the fundamental aspect of the business. Also, it takes into account the financial and economic factors that influence a business. On the other hand, the technical analysis considers the stock’s price movements and uses the data to predict future price movements. The Securities and Exchange Board of India (SEBI) regulates and governs the stock market. This article explains how to assess fundamental analysis vs technical analysis in detail.
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What is Fundamental Analysis?
Fundamental Analysis considers all the factors that are core to the business. Factors such as financial statements, economic factors, industry, management process, etc. Fundamental analysis helps determine the firm’s intrinsic value to identify whether the stock is overpriced or under-priced.
Therefore, fundamental analysis is an extensive analysis that considers various factors that influence the price of a stock. As a result, through fundamental analysis, you will be able to analyze if the stock is priced in accordance with the broader market.
It takes into account both micro and macro-economic factors that have an impact on the stock price. Therefore, this comprehensive analysis will help know the stock’s intrinsic value.
Following are some of the qualitative and quantitative metrics considered in the fundamental analysis:
- Business Model
- Business Cycles
- Customer Base
- Management Competency
- Corporate Governance
- Industry-wide Growth
- Intangible Assets
- Competitive Edge
- Total Profit
- Company’s Annual Revenue
- Accounting Ratios
- Tangible Assets
In addition to the above, various socio-economic factors also play a role in determining the stock’s intrinsic value.
If the stock’s intrinsic value is less than the current market price, then the stock is undervalued. On the other hand, if the stock’s intrinsic value is more than the current market price, then the stock is overvalued.
As a result, analysts see it as a good opportunity to purchase undervalued stocks. Thus the expectation is that they’ll yield higher returns in the long term. On the other hand, for overvalued stocks, a short position will be assumed with an expectation of price fall in the future.
What is Technical Analysis?
The technical analysis considers the historical stock price movements. It leverages the patterns, trends, and also past charts to forecast the stock’s future price movements.
Technical analysis is backed by data. Therefore, it uses the historical price movements, trade volumes and returns to forecast the stock prices. Moreover, technical analysts are of the assumption that all the fundamental aspects of the stock are already factored in, and they remain unchanged.
Also, interferences from technical analysis give buy and sell signals. Such signals are also known as support and resistance levels.
Furthermore, a technical analyst would see a buying opportunity if the stock price is nearing the support level (lower limit). Since they predict that the prices after reaching the support level will shoot up.
On the other hand, if the price of a stock reaches the upper price limit, then it indicates a fall from thereon. Therefore, a technical analyst would sell the security.
Also, predicting the support and resistance levels requires a lot of experience. Therefore, any wrong prediction may not honour the price range, and the stock price may continue to rise or fall beyond the point. As a result, one can experience significant losses.
There are momentum indicators like RSI, MACD, Moving Averages, etc., that help in predicting the entry and also exit prices of a stock. Furthermore, a technical chart comprises candlesticks that help in analysing the stock price movements. Also, the interpretation of a candlestick can vary from analyst to analyst. Therefore, technical analysis is highly subjective in nature.
Moreover, technical analysis is for short term trading, where you can predict the stock prices for the short term. Thus, investing based on technical analysis can be risky.
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When Should You Use Fundamental and Technical Analysis?
Fundamental and technical analyses suit different sets of investors. On one hand, fundamental analysis is suitable for individuals who have a long term investment perspective. On the other hand, technical analysis is suitable for short term traders.
Long Term Investing
In comparison to short-term trading, long-term investing necessitates a more in-depth analytical approach. Thus, by analysing various micro and macro factors, one can estimate the stock’s intrinsic value. Therefore, In this method, investors can learn which stocks will provide the best long-term returns based on their fundamental values.
Short Term Trading
Technical analysis helps in identifying the short term earning potential of a stock. Therefore, the stock price predictions are based on historical data and will only hold true for the short term. As a result, they cannot be used to make long term purchases.
Fundamental Analysis vs Technical Analysis
Following are the key differences between Fundamental Analysis vs Technical Analysis:
|Basis of Difference||Fundamental Analysis||Technical Analysis|
|Meaning||Considers the fundamental aspects of a business.||Considers historical prices and trade volumes of stock.|
|Purpose||Determines the intrinsic value of a stock. It analyses the company’s financial statements, micro and macro factors, etc., to arrive at the intrinsic value.||Determines the prospective share price based on the historical data. It considers the stock price movements, trade volumes, returns, etc.|
|Time Horizon||Long term||Short term|
|Relevance||Relevant for long term investing.||Relevant for short term trading.|
|Buy and Sell||Undervalued: Buy the stock Overvalued: Sell the stock||Trend lines, momentum indicators, moving averages, support and resistance levels will help in identifying entry and exit prices.|
|Data||Both past and present data is considered.||Only past data.|
|Indicators||Revenue, expenses, assets, liabilities, financial ratios, other company, industry and socio-economic factors.||Charts, trends and patterns. Moving Averages, EMA, RSI, MACD, etc.|
|Impact of External Factors||Un-impacted||Impacted|
|Type of Investors||Long term investors||Traders|
|Concepts||Return on Assets, Return of Equity, etc.||Dow Theory, Price Data, etc.|
|Interpretation||Backed by qualitative and quantitative factors.||Subjective, varies from analyst to analyst.|
|Methodology||Examines the industry trends, economic outlook, competitors and financial data.||Examines the market psychology alongside the price movements.|