The Stock Market: Fundamental vs Technical Analysis

Analysing the stock market is important before you develop strategies for investment. Now, there are two methods of approaching the subject: fundamental analysis and technical analysis. On one hand, fundamental analysis takes a hard look at a company’s ‘fair value’ (whether it is overvalued or not) and thoroughly examines the history of the company’s performance in the stock market. On the other hand, technical analysis tends to evaluate the company's reactions to market trends, thus giving you an idea of its pros and cons.

In this article, let us understand to what extent investors give importance to these two ways of conducting market research.

• Technical analysis caters more to the current trends of market value rather than the historical reasons.

• Fundamental analysis deduces whether the market price is a correct representation of the market value (intrinsic value of the asset).

• Technical analysis is good for short-term investments, while fundamental analysis helps reap long-term benefits.

At a basic level, fundamental analysis is about gauging a company or a stock’s intrinsic value rather than how it performs at the moment. Under fundamental analysis, the same will be understood against the backdrop of how the economy is faring, GDP, manufacturing, employment rate, etc.

• Unlike technical analysis, fundamental analysis considers both the micro and macroeconomic impacts of the economy on security’s value.

• Therefore, if a fundamental stock or security analysis deduces that the stock's market price does not reflect the market value, that is, the latter is greater than the former, you are advised to invest.

• The logic behind the investment is that the market value will be matched by the market price in the future in the presence of conducive market conditions. Thus, you will stand a chance to gain.

• Therefore, a fundamental analysis aims at predicting a stock’s future market price by looking at its current market value.
   

Quantitative fundamental analysis

As the term suggests, this type of fundamental analysis looks at figures, tables, and graphs to understand how the company is doing in the market at present. Key concepts of gross and net profit margin, liquidity, solvency, efficiency, and valuation can be reduced to figures that can be measured objectively. These calculations can give you a fair idea of a company’s stability and its reputation in the market.
 

Qualitative fundamental analysis

Qualitative analysis of a company deals with certain important subjective components. These include the efficacy of the company’s business model, whether or not it has a competitive advantage, and whether its policies are tenable in the long run. Furthermore, stakeholder satisfaction can be a key indicator for qualitative analysis because it indicates the potency of the particular company’s brand equity.

Technical analysis spends more time gathering trading data on a company and the major trends of its market price. Based on the accuracy of such data, it is possible to identify the pros and cons of a security, and how it could affect a prospective investment. Technical analysis makes two assumptions, according to Charles Dow, before it sets out on its methods:

• The market works with a sentient accuracy, sooner or later reflecting the correct price of a security.

• There is a logicality behind apparently random market price values, and these patterns are identifiable through repetitions over a period.

Therefore, technical analysis is more interested in real-time events in the stock market because it believes in fair competition reflected in market price.

Like all theories, fundamental vs. technical analyses have their advantages and drawbacks. Since fundamental analysis is more thorough with the historical reasons for a company’s performance, it is best to apply it for long-term investments. Alternatively, technical analysis accurately understands the current trends and can apprise you of the short-term value to be derived from a stock. With fundamental analysis, you need to trust the process and keep your holdings, while with technical analysis, you should react by predicting market psychology.

Technical analysis may be profitable for the short term, but it is not conclusive about long-term benefits. Fundamental analysis, again, has all the reasons sorted but fails to predict when you will reap the fruit of your investment. Having said that, both are useful methods of understanding the market, and you should use them according to your financial goals and requirements.