Fundamental analysis vs technical analysis

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So, if you’ll recall the last chapter, you’ll remember that we touched briefly upon technical analysis towards then. Let’s get to know more about this technique and see how it differs from fundamental analysis. 

To understand the difference between fundamental vs technical analysis in a layman’s terms, you’ll need to meet Suraj and Pankaj.

They’re both looking for houses in the real estate market. However, there’s a difference. Suraj wants to purchase a house. But Pankaj wants to merely rent one.

Here’s a preview of the things Suraj will look into before he buys a house.

  • Is this a good area of the city to buy a house in?
  • Will the value of the land in this area appreciate in the future?
  • What is the neighborhood like?
  • Is the cost of the house reasonable and in line with the market prices, or is it overpriced?
  • Will this investment grow over time?

Meanwhile, Pankaj has other things on his mind, since he’s only renting the house. 

  • What’s the advance that needs to be paid?
  • What have the trends in the rent charged been like over the past few years?
  • How much is the rent likely to increase next year?
  • What’s the rent increase clause for the house like?
  • What are the landlord’s conditions, if any?

See how their priorities and concerns differ greatly? Suraj’s queries are more future-focused and go into the details of the asset and its prospects, while Pankaj is more concerned about the trends in the rent charges.

Drawing parallels, fundamental analysis can help long-term investors, while technical analysis of stocks can prove to be useful for short-term traders. 

Let’s get to know technical analysis a little better before we see how it differs from fundamental analysis.

What is technical analysis?

Say there’s a trader who is looking to make short-term gains by trading in the stock market. He’s been following a stock for quite sometime now. These are the metrics.

  • Currently, the stock is trading at Rs. 80.
  • Over the course of a few days, the stock falls to around Rs. 60. 

At the outset, you might think that this stock is not worth investing since it is on a downtrend. The trader, on the other hand, sees an opportunity to buy this stock.

But how can a stock that’s been falling consistently over a few days open up a buying opportunity? That’s probably the question that’s running on your mind right now, isn’t it? There’s a solid logic behind the trader’s thought process. Let’s take a look at what that is. 

  • The trader has actually been reading and analysing the stock’s past price movements using its 52-week price chart. 
  • Upon thoroughly analysing the price charts, he discovered that the stock has had many ups and downs over the entire 52-week period.
  • In spite of the swings in its price, the stock refused to fall below Rs. 50. And, it always bounced back up after briefly touching the nearabouts of the Rs. 50 mark.    
  • Since the stock had been following this pattern over the course of the 52-week period, the trader concluded that this is likely what would happen this time around as well. 
  • Based on this analysis, the trader bought the stock at the current trading price (Rs. 60). 
  • So, even if the stock slides down even further, the trader is certain that the price would not fall below Rs. 50. And that it would bounce back up after touching the mark in just a matter of a few weeks or months. 
  • Once the stock bounces back up above Rs. 60, he plans to sell the shares for a profit. 

This technique that the trader used to identify a short-term buying opportunity is a great example of technical analysis of stocks

Technical analysis defined

Technical analysis can be defined as a technique that’s used to predict the future price movement of shares using their historical data. It involves the study of charts, graphs, patterns, and trends to identify trading opportunities. Two of the most important share data that technical analysis of stocks utilises are - price and volume.

Now that you know what technical analysis is, let’s do a quick comparison to see what makes it different from fundamental analysis.

Fundamental analysis vs technical analysis

As you know by now, both fundamental and technical analysis are essentially two sides of the same coin. They each propose a different technique of analysis of a company’s stock. Here’s a look at some of the primary differences between these two schools of thought. 

 

Fundamental analysis 

Technical analysis

Sources of data used

Fundamental analysis utilises the financial, management, and industry data of a company.  

Technical analysis utilises historical price and volume movements of the shares of a company. 

Purpose of analysis

This technique is used to evaluate the intrinsic value of a company and to determine whether the stock is undervalued or overvalued.  

This technique is used to identify trading opportunities. 

Timeline

Fundamental analysis has a long-term investment outlook.  

Technical analysis has a short-term investment outlook.

Metrics examined

This approach examines a company’s assets, liabilities, revenue, expenses, cash flows, and financial ratios.   

This approach studies the price and volume charts, graphs, trends, and patterns of a stock.   

Nature of information used

Fundamental analysis bases its investment decisions on the company information.  

Technical analysis bases its trading decisions on the market information. 

Wrapping up

Rounding back to fundamental analysis, you see how it bases the investment decision on the company information? At this juncture, you may want to recall an important document we discussed in the previous module - the annual report. This document, prepared by the company itself, contains a lot of valuable information that makes fundamental analysis possible. 

Head to the next chapter to find out more about the annual report.

A quick recap

  • Fundamental analysis can help long-term investors, while technical analysis can prove to be useful for short-term traders. 
  • Technical analysis can be defined as a technique that’s used to predict the future price movement of shares using their historical data. It involves the study of charts, graphs, patterns, and trends to identify trading opportunities.
  • Fundamental and technical analysis techniques differ on various fronts, like the sources of data used, the metrics examined, the investment timeline they’re useful for, and the purpose of analysis itself.
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