Fundamental Analysis vs. Technical Analysis – Know The Difference
Investors who are skilled at playing the stock market for profit typically use one of two types of forecasting and research tools for future trends with different stock values. These tools are known as “fundamental analysis” and “technical analysis.” As with any stock trading philosophy or strategy, there are advocates and adversaries of both.
A Basic Comparison
Fundamental analysis evaluates securities and stocks by measuring a stock’s intrinsic value. The fundamental analyst studies everything from a company’s financial position and management structure to the overall economic and industrial conditions. When using fundamental analysis, we look for certain characteristics such as assets, liabilities, earnings, and expenses.
Technical analysis differs in that it is based on the price and trading volume of different stocks. It assumes that all the existing fundamentals are factored into a stock’s price, so the investor or trader doesn’t have to pay that much attention to it. Unlike the fundamental analyst, the technical analyst doesn’t try to measure the intrinsic value of a security or stock. Instead, they use charts to identify certain trends and patterns that could indicate the future movements of a stock.
Breaking down Fundamental Analysis
Investors and traders use fundamental analysis to measure a company’s health and performance by examining economic indicators and key numbers. Its purpose is to help you identify fundamentally strong or weak companies and industries. Investors tend to go long and purchase stocks because they expect them to increase in price or value. Conversely, they will go short when they believe that these stocks will decrease in price or value and will re-purchase them at the lower price.
When evaluating a stock’s or security’s value, fundamental analysts rely on real, public data. Furthermore, most of these individuals will use this valuation method for almost every type of security. For example, you can use fundamental analysis on bond values by examining the state of the economy, interest rates, and other factors. You can also research the issuer of the bond for specific information such as any history of credit rating changes.
Fundamental analysts will use other data and factors to determine a company’s potential for growth in the future as well as their underlying value when they’re looking at specific stocks and other equity instruments. These factors include:
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earnings
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future growth
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profit margins
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return on equity
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revenues
Additionally, they will focus on that company’s financial statements. One of the best examples of a successful fundamental analyst is Warren Buffet.
Qualitative Components
Fundamental analysis is comprised of three key components – financial statement analysis, qualitative factors, and valuation analysis. By analyzing financial statements, you can identify the strength or weakness of a company, forecast its future earnings, and compare it to its peers. Qualitative research can be applied at the company level and/or the industrial level. Analyzing valuation enables you to determine the price you should pay when investing in that company, especially its future earnings.
Where qualitative research is concerned, there are different factors that must be identified at the company and industrial levels. At the company level, these factors include the business model, the company’s competitive advantage, its corporate governance, its customer base, and its management structure. At the industrial level, the factors that must be included in the analysis are the competition, industry growth, market share, and regulatory authorities.
Breaking down Technical Analysis
Another trading discipline commonly used by investors is technical analysis. It is used to evaluate securities and stocks in order to determine if a trading opportunity exists. The technical analyst with examine statistical trends that arise in trading activities such as a stock’s price movements and trading volume. The technical analyst will focus on analytical charting tools, price movement patterns, and specific trading signals in order to determine the strength or weakness of a specific stock or security.
This method was introduced in the Dow Theory by Charles Dow in the late 19th century. Today, technical analysis has greatly evolved and includes price movement patterns and trading signals. Consequently, the technical analyst contends that the most valuable indicators of any stock’s price movements are its past price changes and trading activities. It can also be used in conjunction with intrinsic value considerations or independently of other research studies.
The 2 Basic Assumptions of Technical Analysis
According to Charles Dow, there were two underlying assumptions of technical analysis. The following assumptions still form the basic framework for trading stocks and securities with this method:
Basic assumption #1 – market value efficiency is based on factors that influence the price or value of a stock or security. This means that a stock’s market price or value reflects all the information that’s available at any given time. Therefore, it represents that stock’s true value. Basic assumption #1 is based on the concept of a stock price reflecting the market participant’s knowledge. Although it is believed to be true in most cases, it can be affected by announcements or news that could impact the long-term or short-term influence on that stock’s price or value.
Basic assumption #2 – price movements in the market are by no means random and tend to move in patterns and trends that are easily identifiable and will repeat over time. This second assumption of technical analysis is the notion that changes in a stock’s price or value are by no means random and leads to the belief that long-term and short-term market trends can be identified. In so doing, it enables the investor or trader to profit from investments that are made based on analyzing those trends.
Picking Stocks with Fundamental Analysis
Many stock market traders contend that fundamental analysis is the foundation of most stock trading strategies as well as the very cornerstone of investing. It involves the use of certain qualitative and quantitative factors to evaluate a stock or security and answer such questions as:
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Are company revenues growing?
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Can the company pay off its debts?
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Is the company profitable?
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Will the company keep pace with or surpass the competition in the future?
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Finally, and most importantly, should you invest in this company’s stock
A company’s financial statements (balance sheets, cash flow statement, and income statement) are key components of fundamental analysis. You’ll want to pay close attention to specific figures such as debt-to-equity ratio, net income, price-to-earnings ratio, and profit margins.
Picking Stocks with Technical Analysis
Technical analysis helps forecast the future price movements of stocks by analyzing its current and past market actions. Price charts and other analytical tools (e.g. chart patterns and technical indicators) are used to evaluate the strengths or weaknesses of a stock and predict any potential price changes in the future. Conversely, fundamental analysis evaluates the intrinsic value of a stock or security. So, what makes technical analysis so effective for some stock investors and traders?
As an evaluation method, technical analysis presupposes that a stock’s price or value moves by virtue of trends that have been determined by an investors or traders attitude towards changes in economic and financial, as well as political and psychological forces. Consequently, you can analyze the history of a market’s actions to forecast price movements in the future. However, the effectiveness of any such strategy will depend on the investor’s response to the results and the quality of their analysis.
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