What are the differences between fundamental analysis and technical analysis? These are two schools of thought investors use to trade in the stock market. Is one better than the other? It largely depends on your investment goals, philosophy and time horizon. Both can apply to your investment decisions. Let’s discover the main differences between the two strategies.
What is fundamental analysis?
Fundamental analysis deals with the intrinsic value of a company.
What does intrinsic value mean? It is related to all the fundamental and objective factors that can influence the direction of a long-term action..
Investors who use fundamental analysis are looking to buy a stock that has the potential to grow over time.
They want to buy the stock and forget about it until the time is right. So what should you look for before buying a stock?
Fundamental vs Technical Analysis with Economic Conditions
First, how is the economy in general? Many factors can determine it in fundamental analysis versus technical analysis.
We can agree that a global pandemic, wars and weather disasters are not optimal investment scenarios.
They can last from a few days to a few months and years.
However, they can be good buying opportunities when timed well. Today, tensions between Russia and Ukraine created global uncertainty and kept markets on edge.
We can also take a look at the economy itself. If macroeconomic indicators such as GDP, consumer spending, house prices are on the rise, this is generally a positive indicator. Another good indicator is low and steady inflation (2%) and unemployment (4-5%).
Fundamental investors try to find the best possible time to buy a stock, at the start of an economic recovery, to maximize their gains.
Today’s economy is in a unique situation. The pandemic has paralyzed many countries. Consumer and real estate prices are rising rapidly, but wages are not.
Governments have already spent a pretty penny to keep many businesses and individuals afloat. All this led to a rise in the inflation rate. Making sense of all these factors is not an easy task for fundamental investors.
Next, in fundamental versus technical analysis, is the industry growing or has it peaked? Industry life cycle analysis is essential.
Some industries like technology, pharmaceuticals, finance, and natural resources have a very long life cycle. They are constantly evolving and developing to meet our daily needs. If we anticipate a breakthrough, we should most likely invest in this sector. It is also important to choose the best stocks in the sector. We will come back to this later.
The financial sector has perhaps been one of the most consistent sectors for investors since its inception. Banks and transaction intermediaries must stay at the top of their game to attract as many consumers as possible.
blockchain technology found their place in the economy. In recent years, they have tried to disrupt the way money flows around the world. Many investors believe in this market and bought in its early stages. Few of them can predict where it will be in a few years.
Natural resources are also an interesting sector with many ups and downs. We are slowly seeing a global transition to new and cleaner resources. Prices are constantly changing, especially in the event of a territorial or global dispute. It is important to keep an eye on the price of different indices and the companies that exploit and innovate with these resources.
Finally in fundamental analysis vs technical analysislet’s take a look at the company itself. We need to look at its overall picture. This includes financial statements, management, competition, business concept, potential growth, etc Digging through all the publicly available information can be a tedious task, but consider your potential gains.
Fortunately, analysts are paid to publish their findings for us. This is no excuse to avoid doing our own due diligence. Analysts issue recommendations on whether the company is overbought or oversold, and their price target. Let’s take a look at Alphabet, or too a lot, Google (NASDAQ: GOOGL).
Its price is currently below $2,800. Its overall rating is a Strong Buy. Analysts expect the stock to range in the next 12 months between $3,000 and $3,900.
Many businesses and industries are in their infancy. They do not necessarily have an analyst who follows all their movements. Fundamental investors want to invest in the stock and in the sector before it becomes mainstream.
What is Technical Analysis?
Technical analysis is widely used by traders. The main objective is to identify trading opportunities based on patterns.
Traders look for an entry point and an exit point using different metrics including price and volume.
Past performance is an indicator of future movements. It is therefore used for short-term investments. This method can be used for stocks, currencies, options, commodities, etc.
Many companies and individuals have tried to create the best possible tools to predict stock movements.
This can be done by gathering as much data as possible and trying to create patterns for the future.
Technical analysis is not perfect. Many traders can use the same entry and exit points. In order to have real success, it is necessary to be creative.
Critics of technical analysis rely on the efficient market hypothesis (EMH). The EMH claims that the stock price is already reflected by existing information. However, this is only a hypothesis. Anyone who thinks they fully understand how the stock market works is… get ideas.
The following post gives an excellent summary of the existing indicators. They can be separated into a few categories. Here are a few.
- Trend indicators: the direction of the market
- Momentum indicators: the strength of a trend and when it will reverse.
- Volume indicators: very important in determining a bullish or bearish trend.
- Volatility indicators: frequency of variation in the price of a security in a given period.
It is important for traders to familiarize themselves with them as they are essential.
Seasoned investors often use a mix of fundamental and technical analysis to get a deeper understanding of the company.
For example, fundamental analysis can identify an undervalued stock. Technical analysis indicates an entry point and an exit point. Each method has its attributes.
Fundamental analysis is used by long-term investors. It attempts to measure the intrinsic value of a company.
This can be done by assessing conditions related to the economy, the industry, and more specifically the business itself. Investors are looking at the overall situation and the potential for growth.
On the other hand, technical analysis is a tool for short-term traders. It involves finding an entry and exit opportunity using various market indicators. The past does not repeat itself, but it is a window into what could happen. Charts, models and trends are the main tools. It is assumed that all the fundamentals are already taken into account.
Fundamental Analysis and Technical Analysis – Conclusion
In conclusion, whether you are a short-term trader or a long-term investor, it is essential to do your due diligence before buying a security. The two main schools of thought are fundamental analysis and technical analysis. You don’t have to limit yourself to just one. Using all the tools at our disposal will allow us to deepen our understanding of a business. This will allow us to make more informed decisions when purchasing a security.
If you want to learn more about how you can profit from the stock market, head over to our free library of educational courses. We have something for everyone, including trading options for those with small accounts.
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