The difference between technical and fundamental analysis is that the former predicts prices of stocks based on charts and trends and the later predict them based on an analysis of the industry, company and prevailing economics.
Some people invest in markets based only on fundamental analysis and others swear by technical analysis. That begs the question that if both do the same thing then why do people use one or the other? The answer lies in the differences between them which are illustrated below.
Technical Vs Fundamental analysis
How Technical Analysis works
Technical analysis is a tool that is used mostly by those who consider themselves traders. It is used to track short term investments in the market. It also helps decide good entry and exit points. All of this is done based on data from the past and the supposition that history repeats itself.
The inner workings of technical analysis are far too complex and vast to explain here, so we’ll just take a broad look at it. As said before, technical analysis is used by traders to determine entry and exit points for the market using only charts. It is based on three basic principles which are:
- Market actions and stock prices discount everything else
- Prices always move in trends
- Markets always move in patterns
While using technical, you will employ line, bar and candlestick charts to see the rise and fall of prices. These charts will show you the opening and closing prices of specific stocks. They will also show you the highs and lows for that stock.
One example of technical analysis is the moving average, as seen in the image above. What you are looking at is the chart for the State Bank of India. The line that you see across the chart is the moving average. In this case, the 200-day moving average. What this means is simply that the line represents the average price of SBI stocks over the last 200 days.
How exactly you use this information is a matter best left to a classroom. Not that the information won’t help you but one piece out of context would confuse you more than help. If you want to learn more about this, you can drop us a line.
How fundamental analysis works
Fundamental analysis is a tool that is used mostly by investors. They differ from traders in that they are looking for long term investments (upwards of 5 years). They invest in sectors or companies based on the future potential of that sector/company.
As said before, fundamental analysis is more of looking at the current market situation and predicting the future based on internal and external factors. In fundamental analysis, you examine the performance of the company. You examine its current financial situation and what products it’s offering. You then look at the market to see if there is a demand for that product and how much supply is available.
From there, you move onto examining the industry itself. You examine its performance and try to identify any potential for growth. You then overlay the economic scenario that is and will prevail and make your final decision on investing in that company.
A good example of fundamental analysis is the impact coronavirus has had on the Chinese economy. It has caused a drop of up to 8% in the stock markets. It will also influence the global economy because multiple sectors will be affected directly, or indirectly, by it. For instance, the aviation sector can be said to be in the crosshairs because airlines are stopping service to affected regions to contain the spread to the virus. This will result in lost revenue, one of the first things to be considered in fundamental analysis.
The threat of the virus itself is discouraging travellers from going to what used to be popular haunts. This, in turn, will bring down the earning of hotels, restaurants and other related establishments. Which, in turn, reduces the income from tourism thus turning the market slow and discouraging investments.
What we can see from these two styles of analysis is that each has some very specific and clear ways of determining a good investment. But, traditionally, people following one school of thought (technical analysis) won’t bother with the other (fundamental analysis). But what if there was a compromise? What if you could use both together? Does such a middle ground exist?
The middle ground: Techno-fundamental analysis
I’m sure that at some point you have asked yourself the question that if both work; why not use them together? And that is exactly what has been happening. Investors who were using fundamental analysis saw that technical analysis was good at identifying entry and exit positions because it could be used to predict herd mentality. This led them to incorporate a bit of technical analysis into their purchase of stocks.
What happens when you put these two styles of stock market investments together is that technical analysis tells you the best time to enter and exit the market while fundamental analysis tells you if you have chosen the right stock to invest in. It simply combines the best times with the conviction that it is a good investment.
A good example of a techno-fundamental strategy is CANSLIM. This is a strategy that was developed by William O’ Neil. It takes a company’s earnings, growth products and market condition and direction into account when choosing the right company to invest in. It is an acronym for:
C: Current Quarterly Earnings
A: Annual Earnings Growth
N: New Product, Service or Management
S: Supply and demand
I: Institutional Sponsorship
M: Market direction
As said earlier, the subjects of fundamental and technical analysis are very vast and are best not explain in one blog post. But what can be done is one blog post is to explain the differences between them. The main thing you need to remember is that neither is a bad system to employ. What system you decide to use will depend on what sort of investment you are looking at.