Many people compare technical analysis and fundamental analysis
of market securities to find which approach can provide a better way to earn
consistent profits. Not surprisingly, investors and traders are divided between
the two approaches. On the other hand, others just try their best to use the
combination of both techniques hoping to come up with a better strategy.
In this article, we will tackle the most significant
differences between technical and fundamental analyses. Whether you’re a newbie
or a seasoned trader or investor, this article will help you tread aroud the
two kinds of analyses.
Fundamental Analysis
Fundamental analysis tries to find the enterprise value of
the company. This means that you have to arrive at the business’ intrinsic
value by assessing and evaluating economic factors. These factors are
considered to be the fundamental elements that aid in determining the true
value of a company.
If you are more inclined to conducting fundamental analysis,
you must have ample knowledge in terms of industry analysis, company analysis,
and economic analysis.
The Key Assumptions of Fundamental Analysis
The first major assumption of a fundamental analyst when it
comes to the valuations of security is that
the stock price, even when it is considered overvalued or undervalued,
will correct itself and reflect its intrinsic value.
The second key assumption is that the fundamental analyst
can earn profits by targeting stocks that are undervalued, buying them at a low
price and holding them until the market finally reflects their intrinsic value.
Technical Analysis
Technical analysis is another method of evaluating
securities. On the other hand, the whole process is dependent upon the
statistics generated by the market. The charts and the patterns are the bread
and butter of the technical analyst.
When performing technical analysis, you must remember the
following:
- Technical analysis utilizes the past price movements to try and get an accurate prediction of the future price movements.
- Trends and patterns, rather than the intrinsic value of the stock, are very crucial and important to the technical analyst.
- The current market price is key, and the underlying fundamental factors are not given much emphasis.
The Rules of a Technical Analyst
For technical analysts, the following are the three rules
that they must follow if they want to successfully conduct their analyses.
- Prices discount all of the available information to the public.
- Price movements are not random. As a matter of fact, there are trends behind the price action and they can be seen and established by using technical tools and indicators.
- These price trends and patterns have the tendency to repeat themselves.
READ FURTHER: A Trader's Guide to Technical Analysis of Stocks
Advantages and Disadvantages on Both Sides
Both technical and fundamental analyses have their own
distinct advantages and disadvantages that you should always keep in mind if
you’re going to choose one of them.
Fundamental analysis utilizes analytical methods based on
sound, accurate, and relevant financial data. This decreases the amount of
personal bias that you as an investor may feel. This approach also considers
the long-term economic trends.
On the other hand, fundamental analysis can also eat up much
of your time. On top of that, this approach can easily be too complicated since
it centers to quite a number of assumptions.
Meanwhile, technical analysis provides some insights of the
volume of a perceived market trend. You can judge how the overall market is
performing just by looking at the demand and supply sides, which also give you
some good feel of the prevailing market sentiment.
On the flip side, technical analysis mostly ignores the underlying
fundamentals of a company, country, or asset. In reality, this can be very
risky for the case of longer timeframes.
Conclusion
Choosing between technical and fundamental analysis can be
tough decision to make. You should also consider your own personal goals to
decide which approach will help you achieve them faster and more efficiently. Additionally,
you need to think about the time you would need to spend on each approach, as
well as your risk tolerance and skills in risk management.
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