There are two schools of thought that take precedence for analyzing stock markets – fundamental analysis and technical analysis. However, when it comes to the process of determining the worth of an investment and/or trade the two types of analyses are entirely conflictive in their approach.
Each of these methods comprises distinct qualities that appeal to specific market players. Thus, understanding the difference between fundamental analysis and technical analysis is critical to developing a comprehension of each and utilizing them befittingly.
In this article
The primary distinction between fundamental and technical analysis is that the former involves the process of understanding a stock’s intrinsic or inherent value through the analysis of various factors. In this regard, analysts study elements that can make an impact on the security’s integral value.
Fundamental analysis is an extensive process wherein every factor that has an influence over the price of a security is minutely investigated to arrive at a conclusion. In doing so it helps analysts to understand if a stock is priced correctly with respect to the broader market.
Fundamental analysis takes into account both macro and microeconomic factors that can influence the price of stocks to facilitate a comprehensive analysis. For instance, to derive a conclusive result, analysts study broader components like the country’s economic and industrial conditions, as well as, more particular elements like a company’s management to determine the price of its stocks.
Furthermore, the method also makes use of several qualitative and quantitative metrics to determine the well-being of the company in question. This is another key difference between fundamental and technical analysis.
Some of the qualitative indicators that analysts popularly use to reach the intrinsic value of a stock are –
- Management competency
- Intangible assets
- Competitive edge
- Business model
- Corporate governance
- Industry-wide growth
- Customer base
- Business cycles
A few of the quantitative indicators are –
- Company’s annual revenue
- Total profit
- Tangible assets
- Accounting ratios
Apart from these, a fundamental analyst must also be aware of the socio-economic and political factors that might influence a stock’s value in the future.
Now, if according to fundamental analysis, the intrinsic value of a stock is less than its market price then that security is undervalued. Conversely, if per a fundamental analysis the intrinsic value of a stock is more than its market price then that security is overvalued.
Investors who rely on this determination will then buy a stock if it is undervalued in the expectation to yield significantly higher returns in the long-run. Conversely, market players will assume a short position on a stock when it is overvalued as its prices will soon fall.
In short, fundamental analysis is an approach that is undertaken by investors and works on the principle of “ buy and hold”. Investors who go by fundamental analysis, base their decisions to buy a stock on a comprehensive understanding of a company and hold their investments for a longer period.
However, misinterpreting any one aspect or overlooking a single fundamental factor in this method of analysis may sometimes lead to an inaccurate representation of intrinsic value.
While a fundamental analysis of security accounts for an array of factors, technical analysis solely takes historical data directly related to the particular stock into account. That is the primary difference between fundamental analysis and technical analysis.
Technical analysts base their calculations on data that broadly involves the historical prices of a stock, returns, and volume of trade. Through analysis of said statistics, technical analysts attempt to project future price movements of a security or market. Furthermore, such analysts base their results on the assumption that all other fundamentals have already been factored into the stock’s price, and they remain unchanged.
In short, technical analysis is predominantly based on patterned price movements.
Analysts of this school infer price ranges from a stock’s historical performance patterns which function as a buying and selling signal, also known as support and resistance respectively. That is another point of distinction in the debate of fundamental analysis vs technical analysis.
Now, if the price of a security is moving toward the lower limit of the price-range or support, then a trader shall swoop in to purchase the stock. Per technical analysts, once the price reaches the lower limit, it will shoot up from thereon.
Conversely, if a security’s price is surging towards the upper limit of the price range, then it signals a trader to sell the security in question because once it reaches the ceiling, it will fall from thereon.
However, if the trend does not honour said price-range, then it might continue rising upward or free-falling downward, resulting in substantial losses for investors. Also, technical analysis requires experience as well as knowledge of advanced concepts of stock markets. It is more suited for traders who are looking for short term gains, rather than novice investors or individuals who want to invest in a security based on its long term wealth creation. Investing in stock markets based on technical analysis alone is riskier, therefore.
When to Use Fundamental Analysis and Technical Analysis?
Another critical point of fundamental analysis vs technical analysis is their usage by market participants. Typically, the securities market comprises two types of investors – long-term investors and short-term traders.
- Long-term investment
Long-term investment by virtue requires a more profound analytical approach compared to short-term trading. Therefore, the former category of investors typically resorts to fundamental analysis. That way, investors educate themselves which stock would yield maximum returns in the long-run based on their intrinsic values.
Investors can also use technical analysis for long-term investment by coupling it with its fundamental counterpart to reach a more concrete conclusion.
- Short-term trading
Investors predominantly use technical analysis to determine short-term earning potential of security. Since future projections reached via technical analysis is based on short-term historical data, it cannot be a basis for long-term decisions.
However, unusual events pertinent to factors that determine a stock’s true value might also cause a dramatic price change in the short-run. Therefore, investors might benefit from fundamental analysis in short-term trading; nonetheless, such cases are rare.
Difference between Fundamental and Technical Analysis
The following table illustrates the key points of difference between fundamental analysis and technical analysis.
|Parameters||Technical analysis||Fundamental analysis|
|Purpose||Determining security or market’s prospective patterns by analysing historical price movements and volumes of trade.||Understanding a security’s fundamentals via its financial performance, management, and overall market conditions.|
|Usage||Investors typically use it for short-term trading.||Market participants predominantly utilise it for long-term investment.|
|Buy and sell signal||Support and resistance, moving averages, trend lines, and momentum-based indicators.||Overvalued and undervalued stocks.|
Irrespective of the few points of fundamental analysis vs technical analysis, it is most fruitful for investors to use both for developing a more comprehensive idea.