Investment Basics For Investment Neophytes – Fundamental Or Technical Analysis
There are two common investment and intellectual approaches to be used when investigating any security: fundamental and technical analysis. First: fundamental analysis looks at the company, focusing on the company’s “fundamentals” like its income statements, its assets, its balance sheets, and the price-earnings ratios, and is used to analyse if the company being looked at is a good long-term investment that will eventually make money for the stockholder. All the earnings made by the company will eventually transform into either dividends or capital appreciation (price increases) for the stockholder. Second: technical analysis. Technical analysis is different and focuses almost entirely on the stock price and its patterns rather than looking at the inner workings of a company. These two will be excellently examined in the course of this article.
What then is fundamental analysis exactly? Here are the details of this apparently arcane art. It is the art of looking at the fundamentals of a company. The fundamentals of the company are what drives it and what makes it profitable under this school of thought. The basic underlying assumption with fundamental analysis is that the stock price will reflect either sooner or later the parent company’s profitability. The more profitable the company is, the higher the stock price will be. It is that simple in theory. Investors using fundamental analysis are certain that the price follows the underlying profitability of the company. Fundamental analysis is therefore considered more conservative than a technical analysis approach, which is different and will be explained later. There is far less agreement as to the soundness of technical analysis, but the appeal of technical analysis vis-ŕ-vis a fundamental analysis approach is the perception that one can make a profit more quickly than with a buy-and-hold approach, the typical result of fundamental analysis. The really interesting part about fundamental analysis which makes it an art is that there is no known way of deciding the actual worth of a company because of the vast number and range of variables and economic indicators to consider, from assets to income, to profits, to reputation and the like.
Technical analysis, on the other hand, also labelled chart analysis, is based on completely different assumptions as compared to fundamental analysis. The assumption is that the market is made up of a huge group of speculators and investors behaving in predictable and recurring patterns. The challenge for technical analysts is to therefore find these recurring and identifiable patterns in the price movements and to therefore act on them. Technical analysts therefore do not care about the inner workings of the company because they focus on chart patterns. There are a lot of considerations here. The patterns tend to become obscured in the price trends, since outside events tend to affect the movement of prices. These outside events tend to add noise that distort or change the price patterns of the stock, and technical analysts must always keep a good look out. Technical analysis utilises several tools or techniques to look at trends and patterns on stock price charts. Nevertheless, the goal of all the various tools is always the same - to predict the price movement of the stock. If the prediction made is correct, then a profit will be made.
In summary, what is the difference between fundamental analysis and technical analysis? Fundamental analysis is the practice of looking at a company’s fundamentals, such as assets, value, profits and income statements, because the assumption is that the stock price will eventually reflect the true “fundamentals” of the company. Technical analysis, on the other hand, is the practice of studying a stock’s past prices and trends in an attempt to determine its future prices and trends, because the assumption is that the patterns to the stock price movements can yield valuable information. The two schools of thoughts are different. One is company oriented and the other is price oriented. Both have their merits and shortcomings. Choose one of the two approaches to investment, or maybe try a mixture of both, for yourself and see how you fare in the market.
