There are stark differences in fundamental analysis vs technical analysis. Both approaches can be effective in picking the best stocks, however, it is important for investors to understand the main differences between both approaches. When selecting stocks, investors consider and examine a variety of aspects. 

Each of these strategies has unique characteristics that appeal to various market players. Thus,  recognizing the distinction between fundamental and technical analysis is crucial to having a knowledge of both and employing them appropriately. Both methods of analysis enable an investor to gather data in order to draw a conclusion about their investment decision. These are among the most important things to consider before investing in the stock market. 

Some investors may search for patterns on a chart, while others may research other fundamental aspects of the company. Either way, there are usually two types of approaches - fundamental analysis and technical analysis. Although both of them share the same goal, which is to make money in the market, they are completely different from one another. We will see what are the main differences between fundamental analysis vs technical analysis.

When can you apply fundamental analysis vs technical analysis?

Before we even dive into this topic, we should first consider how you can apply both analyses. Both fundamental and technical analysis may be applied to individual stocks and the overall market. They may also be applied to commodities, and bonds. They serve as a basis for an investor or trader to make his decisions. A crucial part of every trade or investment rests on at least one of these approaches. However, some traders and investors might choose to employ both of these analyses before they commit to a trade or an investment.  

In both trading and investing, the more data and research you have the better prepared you will be to make an informed decision. Due to this fact, being able to incorporate these two approaches is important.

Traders and investors will often gather evidence from a variety of sources. Having data and researching as many sources as possible allows them to construct a more comprehensive overview of the market, and the investment or trades they want to pursue. 

Fundamental Analysis 

The term "fundamental analysis" refers to a thorough assessment of the fundamental causes that determine the interests of the economy, industry, and enterprise. It is intended to determine the true intrinsic value of a stock by assessing financial, economic, and other elements (both quantitative and qualitative). In order to find possibilities where the price of a share differs from its current value. 

There are several elements that influence market demand and supply. These factors are complicated and interconnected. Their impact on pricing might vary throughout a certain period. To generate a thorough fundamental view of the market, a sophisticated model and analysis are necessary.  There are several fundamental analysis books that can help investors understand some of these concepts.

What does fundamental analysis tell you?

There are two main drivers of fundamental analysis - qualitative and quantitative. 

Quantitative fundamental analysis

The quantitative part is fairly accessible and easily researched. It involves going through the company’s financials, market reports, analyzing the competitor’s financials, and ultimately valuing the stock. Some of the key points of quantitative fundamental analysis include:

  • Reviewing the company’s financial statements
  • Analyzing the industry
  • Model the company based on its financials

Qualitative fundamental analysis

When fundamentally analyzing a company through a qualitative approach is often much more complicated. This is because it involves estimating things like brand value, and management quality. These can be highly subjective depending on the analyst that is carrying on the analysis. Some of the qualitative analysis includes:

  • Brand value
  • Management quality
  • Competitive advantages (Moats)
  • Customer loyalty

Advantages of using fundamental analysis vs technical analysis

When it comes to stocks, there are various advantages of conducting an analysis based on a company's financial and competitive status. It is also beneficial to analyze the environment in which it functions. Fundamental analysis is particularly important when it comes to long-term investing. As it focuses solely on the company rather than the stock price provides investors with a notion of what is the actual value of a company. However, it can also be used for short-term investments that are derived based on fundamentals. Some of the advantages of fundamental analysis include:

  • More data-driven
  • Allows investors to make better investment decisions
  • Crucial for long-term investments
  • Allows investors to intrinsically value the company
  • It enables investors to understand the industry
  • Understanding the competition the company faces
  • Allows investors to estimate future growth
  • Gives investors a broader understanding of the risks
  • Calculate if a stock is undervalued, fairly valued, or overvalued
  • Allows investors to calculate expected returns
  • More control over the risks

Market fundamental analysis 

There are also several advantages of using fundamental analysis to research the overall market. It allows you to determine whether we are in a market bubble or if the overall market is undervalued. Thus, fundamental analysis is crucial for a top-down investment approach.

Using fundamental analysis to determine whether the market is overvalued or undervalued can also be used to control portfolio risk. As it can deeply influence asset allocation decisions. Allowing investors to minimize a portfolio's possible downside. 

Disadvantages of fundamental analysis vs technical analysis  

Fundamental analysis has a number of disadvantages. Conducting fundamental analysis research takes time since each individual stock must be researched thoroughly. 

Fundamental analysis and the short-term

Perhaps the biggest disadvantage of using fundamental analysis is that it is unreliable to predict extremely short-term movements. Therefore basing short-term trading decisions on fundamental analysis is a fruitless endeavor. Although some stock price fluctuations are driven by fundamental factors, they usually happen when they come to light. For instance when certain news is released and the share price fluctuates due to that.

Valuation methods are sometimes unreliable

Even when it comes to long-term investing, fundamental analysis can be deceiving. Let us consider the implications of basing investment decisions on models. Analysts build all sorts of models trying to predict how a particular company will do over the long term. Although it is an enticing way of valuing a stock, it can also be completely wrong. Models are based on future assumptions, and unfortunately, these may change drastically through time. Consider for a minute all of the models that were built just before the first quarter of 2020. They were all rendered useless due to the pandemic, and how it structurally changed many businesses across the world. 

Therefore, valuation methodologies, such as the discounted cash flow model, are predicated on a slew of assumptions that are rarely entirely true. They might be when the model is initially built, but as they change over time, the models no longer accurately represent the calculation of the value of a stock. Thus, fundamental analysis-driven valuations are beneficial in a relative sense. As they become highly susceptible to changes in the underlying assumptions that are the basis for valuation. 

It takes time

One of the disadvantages of fundamental analysis that is often overlooked is the amount of time required to do a thorough fundamental analysis. It involves reading financial statements, market research, news, and other analyst research. This is extremely time-consuming, and therefore it is important to make sure you have a good return on invested time when conducting fundamental analysis. 

The importance of fundamental analysis

Most of the investors who prefer to make long-term investment choices begin with a fundamental analysis of a firm, a single stock, or the market overall. Traders use fundamental analysis to analyze economic aspects. 

Such as the general soundness of the economy and specific industrial sector circumstances while analyzing the larger scope of the stock market. They might also choose to use fundamental analysis to determine the supply and demand of a certain commodity. The same can be used to value bonds and determine whether they are expensive, fairly valued, or cheap

Investing

It should be emphasized that fundamental analysis should be the main driver of all long-term investment decisions. Only by researching the company’s fundamentals, and determining what is the competitive landscape of the industry in which it operates can investors make informed decisions. Even if their goal is to invest in stock for a short period of time, fundamental analysis can sometimes be the driver of abrupt price changes.

Trading

Fundamental analysis is also used extensively in trading. Although some short-term trades focus solely on technical analysis, it is not a sound basis on which to trade during longer timeframes. Ultimately fundamentals drive the market over a longer period of time. 

Technical Analysis  

Technical analysis is the practice of analyzing securities based on charts and statistical information. Such as stock prices, historical returns, and trading volume. Technical analysis tries to identify trends in securities based on these factors. While fundamental research seeks to demonstrate the underlying worth of a security or market, technical analysis is intended to give insight into the future price of securities or the market overall based on technical aspects. 

Analysts and traders that employ technical analysis believe that patterns based on historical performance information can predict future performance. Although this is a fair assumption in some cases, it is highly unreliable in the long term. Therefore investors usually use technical analysis as an indicator, but they do not base their long-term investment decisions on it.

What does technical analysis tell you?

Price patterns on a chart are used in technical analysis to indicate where the market is moving. Using numerous indications or patterns to help predict where the price will go next. Technical analysis makes use of graphical representations of pricing demonstrating where the price currently is and where it may move in the future. 

Basing their analysis on support and resistance levels. These are important pricing areas that allow technical analysts to predict the possible downside and upside of a particular stock. Some of these indicators include moving averages, past highs, and lows. It also focuses on previous price levels that the price could not go above or below. The idea is to estimate the supply and demand for a particular asset.  

Through the careful analysis of these indicators, traders will recognize patterns that allow them to use it as trading signals. Technical analysis is a much more subjective approach, and although some indicators can be quantified, it is difficult to use them comparatively between different assets like stocks.

Advantages of technical analysis vs fundamental analysis 

One of the most significant advantages of technical analysis is its emphasis on price movements. While fundamental analysis is mostly focused on the underlying business, when it comes to stocks, technical analysis is mostly focused on price. Therefore it is a much better indicator in predicting short-term price fluctuations. This allows for a better prediction of short-term trends.

One of the biggest advantages of technical analysis is the fact that it is not as time-consuming as fundamental analysis. Therefore you will be able to perform technical analysis on multiple stocks, as opposed to fundamental analysis. This way a technical analyst or chartist, is able to have a much broader universe of investable options.

Price behavior in the short term is influenced by a number of elements that fundamental analysis cannot detect. A chart can show the influences of market mood, market dynamics, and supply or demand.  Technical analysis may be used to enhance timing, depending on how Mr. Market acts. This is particularly helpful when it comes to implementing hedging strategies.

Disadvantages of Technical Analysis vs fundamental analysis 

There are certainly downsides to technical analysis. Overall it is a much more subjective approach to making predictions.

Technical analysis is highly subjective

The first is that, while certain technological techniques can be back-tested, many others cannot. Elliott Wave analysis, pattern trading, and other types of technical analysis are all subjective and rely on human assessment. They are also not easily quantifiable and it becomes difficult to compare trade or investment ideas based on technical analysis. 

More of an art than a science

Using charts is sometimes seen as an art rather than a science. Often, technical analysis is based on uncertain data points that are then used to make subjective conclusions. Therefore two technical analysts might get completely different views when analyzing the same chart and the same data.

It can lead to analysis paralysis

A large amount of hardly quantifiable data that technical analysis employs can leave investors and traders with an unclear view on a certain trade or investment. Charts can look extremely different in various time periods. With so many different analytical methodologies, markers, and timescales to choose from, making firm conclusions can be difficult. This is a common occurrence referred to as analysis paralysis. 

Unreliable for the long-term

The success rate of technical trading strategies in determining the long-term price of an asset is low. While the patterns or setups may provide an advantage in the short term they are incredibly unreliable in the long run.

Highly focused on price

Prices fluctuate daily in the markets. Making predictions solely based on price is erratic. Therefore technical analysis only allows you to understand a certain entry price and a possible exit price for a certain trade. This is somewhat limited, and a full scope analysis that involves fundamental and technical analysis needs to be conducted in order to assess an investment or trade.

The importance of technical analysis

Despite its disadvantages, technical analysis is important both in investing and trading. As a long-term investor, you may still use technical analysis to decide what is the best entry point for a certain investment. It also allows you to understand how the price in the short term might fluctuate. This allows investors to position themselves better, and get a better value for their money.

Technical analysis helps to determine support and resistance levels. Therefore it can be used for both entry and exit strategies. Even an investor that derives most of its investment decisions through careful fundamental analysis, might use technical analysis to determine the best time to sell its investment. 

Technical analysis also gives a much better insight into how the market mood and psychology are. This is undeniable and it is an important factor to consider by both traders and investors.

Bottom Line 

Both technical analysis and fundamental analysis focuses on predicting asset prices. They are both distinct approaches, however, their goal is the same. Although both of them should be used when researching a particular trade or investment, fundamental analysis is by far the most crucial for investors.

In a scenario where you could only use one of the approaches to make investment decisions, the fundamental analysis would be the choice. Ultimately price should not be the main concern of investors. Their goal should be to estimate the price accordingly. In fact, some people would argue that a price of a certain asset could impact our own estimates and predictions. In essence, an anchoring bias that could deeply influence our analysis.

Ideally, a combination of both fundamental analysis and technical analysis should be employed by both traders and investors. Neglecting one of them could be detrimental.

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