You may have heard that traders use fundamental and technical analysis before investing in specific assets on the market. Investors use fundamental analysis to evaluate the intrinsic value of an underlying asset. It’s different from the technical analysis since it focuses on predicting the upcoming price trends.
Fundamental and technical analysis users apply different tools and use data to analyze an underlying asset. Keep reading the article to learn more about each discipline and the difference between fundamental and technical analysis.
What is technical analysis?
Technical analysis is a trading discipline used by traders to evaluate investments and identify trading opportunities. By using technical analysis tools, traders can figure out when to buy or sell stocks, securities, or other assets. Traders analyze statistical trends and trading activity, such as price movement and trade volume.
It’s different from fundamental analysis, which estimates a security’s value based on business results such as sales and earnings. Technical analysis aims to analyze prices and volume.
How does it work?
Technical analysis relies on studying technical analysis patterns and using indicators. Common indicators and charting patterns for technical analysis include moving averages, momentum indicators, trendlines, etc.
Typical types of indicators used by technical analysts are as follows:
- volume and momentum indicators;
- chart patterns;
- moving averages;
- support and resistance levels;
- price trends.
Technical analysis offers traders a comprehensive view of reasons for changes in the prices of an underlying asset. This discipline aims to understand the market sentiment behind price trends by looking for patterns and trends. Most traders use Charles Dow’s framework during technical analysis trading.
According to Dow’s work, analysts accept three general assumptions:
- The market discounts everything. Every factor, including the company’s fundamentals, broad market factors, and even market psychology, is already priced into the stock. Traders must focus on price analysis, which is only influenced by supply and demand.
- Price moves in trends. Simply put, it’s less likely that the stock price will move erratically and more likely for the price to continue a past trend.
- History repeats. Technical analysts believe price movements have a repetitive nature based on market psychology. Many technical analysis tools were used 100 years ago, but they are still relevant, which supports the claim.
Fundamental and technical analysis are two major schools of thought for analyzing markets and trading.
Advantages and disadvantages of the discipline
Most traders prefer technical analysis since it enables them to find entry or exit points in the market quickly. The method has a few other advantages:
- It offers insights into volume trends. Traders easily identify trends based on demand and supply.
- It gives tools to identify entry and exit points. If there’s an increasing demand for an asset, it means an entry point. When the opposite happens, then it’s likely an exit point so that the trader will sell the asset.
- Patterns offer direction. The usage of indicators and patterns enables traders to estimate the intensity of a trend.
The discipline also has a few disadvantages:
- Indicators produce false signals. Traders must use different combinations to verify whether the signal is true.
- Traders ignore fundamentals. Most traders don’t consider the company’s financial health, which could lead to big losses in the long run if an investment fails.
Traders should be extra careful with indicators. If the chart shows a buy signal, it’s critical to verify the trend by using other indicators. Let’s now check what the definition of fundamental analysis is.
What is fundamental analysis?
The fundamental analysis estimates a security’s intrinsic value by analyzing related financial and economic factors. Intrinsic value stands for the investment value based on the underlying company’s financial health and current market and economic conditions.
How does it work?
Fundamental analysts focus on factors that can affect the security’s value. These factors typically include:
- macroeconomic factors, including the economy’s state and industry conditions;
- microeconomic factors, including the effectiveness of the underlying business’s management.
Fundamental analysts aim to find numbers investors can compare. For example, whether the security is undervalued or overvalued, given the current market situation.
Fundamental analysis allows traders and investors to spot securities that are not correctly priced by the market. Fundamental analysts use publicly available financial data of different businesses to estimate the value of an investment.
Advantages and disadvantages of the discipline
Fundamental analysis requires analyzing volumes of public data, but it’s a guarantee of a more insightful evaluation. This method has the following advantages:
- It’s an analytical method. The discipline is based solely on sound financial data available to the general public. It doesn’t rely on personal bias.
- It offers a 360-degree focus. The study often analyzes long-term economic, consumer, and demographic trends, which is great for future investment planning.
- It’s a systematic approach. Fundamental analysts use tools and data that allow spot valuable investment opportunities.
- It gives more insightful information. Financial analysis helps investors or traders better understand the market.
So, the fundamental analysis offers more detailed information on a specific asset. However, the discipline has a few disadvantages:
- It’s time-consuming. Analyzing huge volumes of data takes a lot of time and requires an in-depth understanding of the discipline.
- It’s assumption-centric. Analysts must also consider geopolitical, economic, and other factors, which also takes time.
It takes time to learn how to analyze the market according to fundamental analysis principles. It’s a time-consuming method, and compared to technical analysis, it requires skills and experience. However, the fundamental analysis generates more in-depth reports.
Explaining the difference between fundamental and technical analysis
From the definitions of fundamental and technical analysis, it’s clear that these two disciplines are different. Let’s make things easier and sum up all the major differences in a list:
- Fundamental analysis analyzes longer periods, and technical analysis tracks shorter periods.
- Fundamental analysis examines an underlying asset to estimate its intrinsic value for long-term investment. Technical analysis aims to forecast the underlying asset’s price.
- The fundamental analysis offers investment tools and technical analysis offers trading tools.
- Technical analysis uses data from charts, and fundamental analysis requires data from public sources, economic reports, etc.
- Fundamental analysis uses previous and present data, while technical analysis looks mainly at the present data.
- Fundamental analysis is based on return on assets and returns on equity concepts, and technical analysis is based on price data and Dow theory.
The fundamental analysis enables investors to spot an asset with a lower price while its intrinsic value should be higher. Simply put, you can buy a valuable stock at a lower price, and in the future, the asset’s value should increase. So, it’s a long-term investment.
Technical analysis is used by traders on the market. The discipline gives them tools to forecast the price of an asset. Traders buy the stock when they expect the asset to increase in value. It’s a short-term investment since you don’t analyze the company’s financial health but the supply and demand on the market.