Fundamental Versus Technical Analysis
As you may be able to tell, I am personally a rather large proponent of technical analysis and almost always use technical indicators when trading. It may seem odd that it is possible to pick a stock completely based on charts of the stock’s price movements and volume changes. Afterall, investing in the stock market is ultimately the decision to invest in a company. As a result, the simplest conclusion is that we should know as much as we can about the company in question, correct? Well, if this is how you’re feeling after reading the entries in my blog, then you’ve stumbled upon the great controversy of Fundamental versus Technical investing.
So, what is the difference? Well, as you can tell technical investing is the study of a stock’s price movements and trading patterns. People have created many different charts to help highlight different aspects of a stock’s trading patterns and these are the tools that many people use to analyze these stocks. Why does technical investing work? Technical investors believe that a stock’s price is always reflective of all available information in the market and that any price movements after that will follow a predictable pattern resultant of typical reactions to changes in available information - i.e. big news, earnings reports, etc.
Fundamental Analysis is based on the belief instead that a stock’s price may not be reflective of the true “value” of a stock. This is why Fundamental Analysis and Value Investing are terms which often go hand-in-hand, if not used interchangeably. Now, the true fundamentalist would look at cash flows and earnings reports as well as recent news, management, and a myriad of other qualitative resources to try to estimate the value of a company however many years in the future. If the stock’s price is found to be below this value, then it would be a good buy for a mid or long term investment. However, few people have the time or access to this kind of information (especially things like talking to the management of a company or poring over SEC filings). As a result, various ratios like Price-to-Earnings, Debt-to-Equity, and Earnings-per-share as well as many other basic reports of a company’s earnings and sales growth have been made available in veritable “cheat sheets” for quick fundamental analysis.
While the principles that drive belief in Fundamental or Technical Analysis are somewhat exclusive, belief in each stock selection strategy is not mutually exclusive. A purely technical investor would likely fair better than a purely fundamental investor in the short run and the opposite is true in the long-run. The two strategies can, however, be used together to make very strong mid-to-long run trading strategies. For example, using fundamental analysis to screen for strong stocks that are undervalued and using technical analysis to time the purchase and sale of these stocks. Before we begin thinking this far in advance, however, it’d be a good idea to take a look at a few of the fundamental analysis tools that will aid us in our stock research - which is exactly what I intend to do in ensuing posts on this blog! Stay tuned for the new Fundamental Analysis Series.
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