Understanding the stock market can sometimes feel like reading another language. Whether you are a novice investor or an experienced trader, it is likely that you first came across two types of market analysis: fundamental analysis and technical analysis. Both have the same intended outcome - to help you make good investment decisions - each takes a very different perspective of the market. It is important to know the difference between technical and fundamental analysis so you can implement your own successful strategy and recognize which is more compatible for you as an individual investor.
This guide will outline the technical analysis and fundamental analysis methodologies and outline the main differences between the two, and help determine which analysis, or combination of both, is right for you, given your individual financial objectives.
Understanding Fundamental Analysis (FA)
Fundamental investing is simply the study of how a stock price is affected by the "why." It is like being a financial detective; here, you would explore a company to determine its intrinsic value, not the market price alone. When you look at a company through a fundamental perspective, you are deciding what the company is actually worth, as you are convinced the item will ultimately trade at that intrinsic value.
What Is It?
Fundamental analysis in stock market analyzes all factors that could impact a company's value. This process entails a thorough evaluation of the company's financial condition, management, industry trends, and economic environment. The aim is to identify whether the stock is currently trading at an undervalued price (a reasonable purchase) or an overvalued price (an avenue for a sale).
Key Components & Tools:
Financial Statements
This is the foundation of fundamental analysis. You will evaluate a company's:
Balance Sheet: A breakdown of a company's assets, liabilities, and equity at a point in time. If you'd like to dig deeper, check out our article on How to Analyze a Company's Balance Sheet.
Income Statement: Shows a company's income, expenses, and profits over a period of time.
Cash Flow Statement: Shows how a company makes and receives cash.
Key Ratios
When analyzing financial statements, you will compute ratios like Price-to-Earnings (P/E) ratio, Earnings per Share (EPS), Debt-to-Equity, Return on Equity (ROE), and many others. These ratios are helpful for comparing a company's performance against its peers and industry averages.
Qualitative Factors
In addition to quantifying numerical metrics, fundamental analysts will consider:
Management Quality: The skill and integrity of the management team.
Competitive Advantage (Moat): What makes the company and its business hard to replicate (e.g., strong branding, patents, or network effects).
Industry Outlook: The health and outlook of the company's sector as a whole.
Economic Indicators: Using broader economic indicators like GDP growth, inflation, and interest rates, which will affect all businesses.
Understanding Technical Analysis (TA)
Whereas fundamental analysis focused on the "why," technical analysis focused on the "what" - specifically, what is, or has been, the market price doing? Technical analysts believe that all fundamental information about a stock is contained in the stock price. Their primary tools involve working with charts, patterns, and indicators to forecast price movements based on all historical information.
What Is It?
Technical analysis is the study of historical market data - price and volume - to predict future price direction. Its premise is built on the thought that things in the past have a tendency to happen again, given that people's emotions and psychology play a consistent role in the buying and selling process.
Key Components & Tools
Price Charts
The visual component of technical analysis. You will look at different types of price charts, such as:
Candlestick Patterns: These graphical representations are important. If you are new to candlesticks, then check out What is a Candlestick Pattern? Explained for Beginners.
Bar Charts
Line Charts
Chart Patterns
Repeating shapes or forms on the price chart, which are usually associated with predictable price movements, such as Head and Shoulders, Double Tops/Bottoms, and Triangles.
Technical Indicators
Mathematical calculations based on price, volume, or open interest, plotted over the price charts. The technical indicators provide insights into the momentum, volatility, or strength of a trend. Examples include:
Moving Averages - Simple, Exponential
Relative Strength Index - RSI
Moving Average Convergence Divergence - MACD
Stochastic Oscillator
Many of these indicators we have touched on in our guide, Top Technical Analysis Tools Every Trader Should Use.
Support and Resistance
Price levels where buying or selling may be strong enough to create a pause or reversal in prices.
Volume Analysis
The quantity of shares that have been traded is used to validate the strength of price movements. In derivatives, understanding Open Interest in Derivatives is also important, as we have described.
Key Differences Between Technical and Fundamental Analysis
To summarize, here is a direct comparison to highlight the difference between technical analysis and fundamental analysis:
Which is Right for Your Investing Style?
Whether your choice is technical analysis or fundamental analysis greatly depends on your investing style, financial goals, time horizon, and risk tolerance.
You're more Fundamental Analyst if:
You're a long-term investor & want to build wealth over the years, not over weeks.
You want to understand the businesses you invest in, not just trade their stock.
You believe in value investing, which is buying quality assets when they are undervalued.
You are someone who has the patience to ignore short-term volatility in the market.
You are building a retirement portfolio.
You lean towards Technical Analysis if:
You are a short-term trader (like a day trader or a swing trader).
Your main goal is to take advantage of price movements and market timing over a period of time.
You trade a lot, and you are willing to have higher transaction costs and risk.
You are interested in pinpointing specific entry points and exit points in your trades.
You are actively trading on the derivatives market.
The Hybrid Approach: Using One and the Other to Improve Your Decision Making
Many of the successful investors and traders do not use one method exclusively. They take a techno-fundamental analysis approach and use both methods to capitalize on their strengths.
They may use fundamental analysis to identify fundamentally sound companies that have great growth potential and intrinsic value. This gets rid of the weak companies.
They are then able to utilize technical analysis to identify optimal entry and exit points for fundamentally strong stocks. For example, the fundamentally strong stock may have been temporarily oversold on its charts. However, this short-term, temporary oversold condition is a chance to buy, which can be confirmed using technical analysis.
This hybrid approach allows investors to continue to identify high-quality investments and then complete price trading in and out of the investment to potentially achieve maximum return and minimize risk. If you would like to learn more and practice these concepts, check out our Stock Market Training Online Courses for any level of investor or trader.
Conclusion
In the end, there is no "best" way to analyze the stock market. The difference between technical and fundamental analysis is in their focus and where they are used. With fundamental analysis, you will start with an understanding of what stocks to buy, which focuses on the fundamental value of the company, making it a good fit for long-term investing. Whereas, technical analysis will give you an understanding of when to buy and sell, focusing on market behavior, and is an appealing method for short-term trading (like day traders).
Your path through the financial markets will be uniquely your own. Be sure to check out some of the distinctions of both fundamental and technical analysis methods, and use your personal investment style and financial goals to determine what fits your needs. Many find that a well-informed combination of each strategy provides the strongest chance of success.
What do you prefer? Do you prefer technical analysis or fundamental analysis, or some combination of the two? Let me know in the comments below.
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