Technical Analysis vs Fundamental Analysis | A Complete Beginner’s Guide (Part 5)
In the stock market realm, there are only two methodologies traders use to evaluate, analyze, and predict the future growth or imminent trends of stocks. Technical analysis and fundamental analysis have respective followers. A dividing line has been drawn to separate the opposing interpretations. Since both are stock investment strategies with the end view of achieving winning trades, why not use both?
Differences between technical and fundamental analysis
It’s interesting to note the differences between the two strategies. Whether which side of the fence one belongs to, the school of thought is firm. None would give an inch to the other. They stand by their principles that the parties become adversarial at times.
Let us recap and revisit the central doctrines of the two stock analysis methods:
Fundamental analysts measure the intrinsic value of a particular stock. They review nearly everything about the company. The data contained in the set of financial documents such as the income statement, balance sheet, and cash flow statement among others will be scrutinized.
Industry standing and conditions are also taken into account including the management style and competence. Assets and liabilities plus profits and expenses are all placed under the microscope. In short, the analysts leave nothing to chance.
Technical analysts pay little attention or none at all to the dizzying numbers. Instead, their evaluation of stocks is based on statistics created by the market activity of the stock itself. The analysts do not look at the intrinsic value of the stock. They rely exclusively on the past and present prices and trading volume.
The analysts have the uncanny ability to anticipate price movements using stock charts. From the charts, they are able to identify trends and patterns. That alone gives them the confidence to trade effectively.
Answering the question as to which of the two is the better strategy is quite contentious. Only the investor can answer that query. If you’re into facts and figures, fundamental analysis would be your best bet. However, if numbers are not your thing but you have a fascination with charts and patterns, then the technical analysis is your game. Anyway, let us review what’s best and what’s not with the two to have a better perspective.
The Pros and Cons
- In-depth review of the financial data to arrive at the intrinsic value
- Computing for the financial ratios will give hints as to the main strength and weakness of the company
- Enables analyst to get the overall pulse of the company – the present financial state and condition as well as potential in the future
- Review takes time and wearisome that it can lead to delays
- Extrapolation of numbers is cumbersome time with no reliable trade signals to offer
- The long-drawn review can result in off-timing in entering a trade that you end up holding a stock for a longer period due to the wrong timing
- Charts and patterns give out reliable trade signals as historical price data and future price movements or trends in the future can be highlighted
- Price targets can easily be established by reading trend lines and chart patterns
- Traders can prepare to execute enter and exit trades in timely fashion
- Learning curve to master the art and develop the skill is longer – without the proper know-how and incorrect use can be disastrous
- Stock charts are not 100% safe as volatility and the element of surprise are ever present – the predicted price movement can be altered by unforeseen market events
When each strategy should be used
While the debate rages on, it is important for an investor to consider the sensible use of each methodology. The circumstances should dictate which strategy applies.
Given the documented financial evidence, fundamental analysts have a solid basis to make sound investment decisions, especially for those with long-term investment objectives. It is easier to validate the stability of a company from the actual financial information. The good numbers will eventually be manifested through increased stock prices.
However, the stock price of a fundamentally sound company may experience price fluctuations that are not directly linked to their innate value. Geopolitical events and economic data can influence price movements that have little to do with fundamentals.
Such factors may have an impact on the stock’s short-term price movement but not necessarily a long-term effect on its value. Regardless of direction, using technical analysis to identify the short-term price movement is appropriate notwithstanding the equity’s long-term value.
In certain situations, technical analysis is also more favorable than fundamental analysis. Technical analysis is an effective tool for short-term trading objectives. Traders seeking to profit straight out from the trade can simply follow the trend of a stock’s price movement.
Blending the methodologies will prove superior
In the final analysis, the best stock investment strategy to use is the third method. Blending the two opposite thinking could work wonders and prove superior to any of the methods taken individually. Some traders have already assumed a neutral position. Rather than rely on one method, their formula for success is to combine and use both.
Usually, they will perform the fundamental analysis first. That will give them an indication of the company’s viability as a good investment prospect. After obtaining a valuable insight, the trader will next use technical analysis. It will guide them determine the best possible time to execute the trade, whether an entry or exit mode. Thus, a combination of both strategies increases the possibility of a profitable trade.
Technical analysis offers excellent opportunities to profit from short-term price movements by picking stocks that were evaluated using fundamental analysis. Therefore, technical analysis and fundamental analysis can be complementing after all. An investor should realize that no single methodology is the best. The important thing is to learn how to use technical analysis or fundamental analysis and when. That is the key. The debate is over.