FUNDAMENTAL V/S
TECHNICAL ANALYSIS
There are two general
schools of stock analysis: fundamental and technical. This feature describes
the two schools and the key differences between them.
Fundamental Analysis
Fundamental stock
analysis requires, among other things, a close examination of the financial
statements for the company to determine its current financial strength, future
growth and profitability prospects, and current management skills, in order to
estimate whether the stock's price is undervalued or overvalued.
A good deal of
reliance is placed on annual and quarterly earnings reports, the economic,
political and competitive environment facing the company, as well as any
current news items or rumours relating to the company's operations.
Simply put,
fundamental analysis concerns itself with the "basics" of the
business in assessing the worth of a stock. Numerous ratios, derived from
balance sheet and income statement data, are used in fundamental analysis
including such widely used ratios as, Working Capital Ratio, Debt-equity Ratio,
Return on Equity Ratio, Earnings per Share, etc.
Fundamental analysis
may be the preferred method to use for mid to longer term investors. However,
it is not suitable for use by day traders because of the amount of research
required, and the fact that trades are entered into and exited within a very
short time frame.
Technical Analysis
Technical analysis
does not concern itself with a company's basics or fundamentals. Rather,
technical analysis involves the study of a stock's trading patterns through the
use of charts, trend lines, support and resistance levels, and many other
mathematical analysis tools, in order to predict future movements in a stock's
price, and to help identify trading opportunities.
The basic foundations
or premises of technical analysis are that a stock's current price discounts
all information available in the market, that price movements are not random,
and that patterns in price movements, in very many cases, tend to repeat
themselves or trend in some direction.
Bob Prechter, a
famous practitioner of technical analysis once commented that, "... the
main problem with fundamental analysis is that its indicators are removed from
the market itself. The analyst assumes causality between external events and
market movements, a concept which is almost certainly false.
But, just as
important, and less recognized, is that fundamental analysis almost always
requires a forecast of the fundamental data itself before conclusions about the
market are drawn. The analyst is then forced to take a second step in coming to
a conclusion about how those forecasted events will affect the markets!
Technicians only have one step to take, which gives them an edge right off the
bat. Their main advantage is that they don't have to forecast their
indicators."
A very large number
of technical indicators have been developed over the years, including the
widely used overbought/oversold indicators such as the Relative Strength Index,
and the trend following indicators such as Moving Averages.
While technical
analysis can be a great help in trading the market, no technical indicator is
infallible. Further, technical analysis is only as good as its interpreter.
Finally, a significant of time must be spent in learning the principles of
technical analysis, and in how to properly interpret the various charts and
other technical indicators.
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