Last updated on May 12, 2022
When talking about the analysis of the stock market, there are two different schools of thoughts that prevail among the investors and traders. Often the traders and investors, specifically those who are new to the stock market world, are confused about when to use technical analysis and when to opt for fundamental analysis.
Each of the two stock analysis methods comprises of distinct qualities that manage to attract specific market players at a time. This makes it essential for traders and investors to learn the difference between technical analysis and fundamental analysis. It is critical to developing a comprehension of each and utilizing both the methods befittingly.
What is Fundamental Analysis?
Fundamental analysis is more of a detailed analysis and examination of the basic factors. These are the factors that have an influence on the interest of the economy, the industry as a whole, and the company. Fundamental analysis is the process of deciphering and understanding a stock’s intrinsic value or inherent value by analyzing various factors.
Fundamental analysis takes into consideration both macro and micro-economic factors. In other words, all the factors that influence the stock’s price are considered to have a comprehensive analysis. All the qualitative and quantitative indicators that can affect the stock price are also considered.
Some of the qualitative indicators that are considered include business model, intangible assets of the company, management’s competence, customer-base, business cycle of the organization, etc. The quantitative indicators taken into account include accounting ratios, the company’s annual revenue, the total profit of the company, and the organization’s tangible assets.
What is Technical Analysis?
Technical Analysis is majorly used to forecast the prices of a share. The technical analysis states that the stock’s price is based on the interaction of the demand and supply forces that are operating in the marketplace.
Technical analysis is primarily used to forecast the future market price of the stock based on the stock’s past performance and past statistics of the share. The prices of the stocks are ascertained to see how the prices of the stocks are likely to change in future when using technical analysis.
This is also one of the basic differences between technical analysis and fundamental analysis. Technical analysts base their price calculations on the data broadly involving the historical price of the stock, return, and the volume of trade. Technical analysis is based on the assumption that all the other fundamentals affecting the stock price have already been factored into the stock’s price and will remain unchanged.
Difference between Fundamental Analysis and Technical Analysis
- Fundamental analysis is a method of stock analysis that aims at identifying the intrinsic value of the stock for long-term opportunities. Whereas, technical analysis is used for evaluating and forecasting the stock price in futures based on price movement and volume of trade. It aims at identifying how the stock will perform in future.
- Under fundamental analysis technique, longer periods are used for analyzing stocks as compared to technical analysis. Thus, fundamental analysis is used by those investors who are willing to invest in stocks that will grow in value in several years. Technical analysis, on the other hand, is used when the trade is only for the short term.
- Technical analysis is related to trading, while fundamental analysis is associated with investing. Hence, this is the other area where the time difference between the two approaches is the basis of differentiating between the two. Investors use fundamental analysis to buy and hold the stocks of a company, while traders rely on the technical analysis as they are interested in making short term profits.
- Fundamental analysis aims at calculating the true intrinsic value of the stocks. In contrast, technical analysis, on the other hand, aims at identifying the right time to enter or to exit the market.
- The fundamental analysis method is used to make decisions based on the information and the statistics that are evaluated. On the contrary, the technical analysis makes a decision based purely on the market trends and the prices of the stock.
- Fundamental analysis takes into consideration both the present and the past data related to a stock’s performance. In comparison, the technical analysis method uses only the past data related to stock prices.
- Fundamental analysis considers financial statements as well, while technical analysis uses charts and indicators with price movements.
- The intrinsic value of the stock using the fundamental analysis can be calculated by analyzing a company’s income statement, balance sheet, cash flow statement, profit margins, return on equity, the price to earning ration, and other such quantitative measures. Technical analysis as an approach to stock analysis relies on technical indicators and charts, chart patterns, price actions, resistance and support, analyzing the future price trends, etc. Resistance is the point where the investor believes that the price of the stock will not rise further and is ready to sell. Support, on the other hand, is a point where the investors are assured that the price of the stock under review will not fall further and hence is ready to buy the stock.
- Fundamental analysis is conducted for long-term position trade, whereas, swing traders and short-term day traders use technical analysis.
- Fundamental analysis is used to decide the future price of the stock based on its past and present performance and the profitability of the company. However, under technical analysis, the future prices of the stocks are ascertained on the basis of charts and technical indicators.
When to use Technical Analysis and Fundamental Analysis?
The other major point of confusion among the investors and traders is to decide when to use which of the two methods, i.e., fundamental analysis and technical analysis to make profitable market decisions. Investors in the stock market are typically classified into two broad categories- long-term investors and short-term investors.
Long-term investors: Long-term investments require a more analytical approach compared to short term trading. Hence, for this category of investors, it is suitable to opt for fundamental analysis technique. By using fundamental analysis, stock traders educate themselves about which stock would yield maximum returns given the long duration of the investment. Furthermore, the fundamental analysis also calls for looking at the qualitative aspect of the company, which is done in the fundamental analysis and not in technical analysis.
Short-term trading: As the name suggests, short-term trading is conducted by traders to make quick profits. Hence, they should opt for technical analysis method which determines the short-term earning potential of security. Technical analysis is based on short-term historical data, and therefore, it cannot be used for making long-term decisions. Technical analysis is thus suitable for the traders who are looking forward to predicting the future price of the stock based on the past trend of price movement.
To conclude, under fundamental analysis, the stock is bought by the investor when the market price of the stock is below the intrinsic value of the stock. Whereas, in technical analysis, a trader buys the stock when they expect that the stock can be sold at a relatively higher price in coming future. Which of the two methods is to be used, hence, depends on the objective of investing and on the basis of whether you are a trader for short-term or want to buy and hold the stock.