When approaching investment in the stock market there are two very common methodologies used, fundamental analysis and technical analysis. As with any investment strategy there are advocates and detractors of each approach.
This article will explain both methodologies so that you can clearly understand the process of fundamental analysis vs. technical analysis.
Fundamental analysis is the approach whereby one tries to calculate the intrinsic value of a stock by looking at the basic economic factors, the fundamentals, which would impact its value.
Relevant factors that will be looked at include: Revenues, expenses and income Growth prospects for the company The competitive factors the company faces Expected return on equity or assets in the industry
The goal of this analysis is to establish a value for the stock that would factor in all of these underlying factors. As the approach doesn’t look at short term pricing and trading swings this is considered a long term investment approach, as it may take time for the intrinsic value to be realized.
As this factors in forward looking expectations this methodology is considered to build a valuation based on backward and forward looking information.
Technical analysis is an investment methodology that evaluates investments purely on the market activity surrounding them, with no looking to the actual operations or value of the company itself.
Relevant factors that will be looked at include:
- Historical pricing of the shares
- Trading volumes over time
- Industry trading trends
The goal of this analysis is to capitalize on pricing opportunities and trends that can be identified in the market activity around each share. As the methodology is purely based on historical market activity this is considered to be a backward looking methodology.
Fundamental Analysis vs. Technical Analysis
When it comes to comparing and choosing a methodology between the two there are two key considerations to factor in.
First, the time horizon of your approach is important to consider.
Fundamental analysis is a long term investment strategy whereas technical analysis is considered far more of a short term methodology.
By pricing on intrinsic values fundamental analysis is working towards the long-term value of a company, whereas by trading on market trends technical analysis is short-term focused.
Second, you need to consider what your investment approach is. Are you an investor or a trader?
Fundamental analysis is investing in companies and relying on their underlying value to drive your returns. Technical analysis is really a trading strategy where you are aiming to drive returns out of identified trends and opportunities.
Trading can take far more active time and management on the part of the investor, though major funds invest millions in sophisticated technical analysis trading software.
The average individual will likely be far better served focusing on a fundamental analysis investment strategy.