Understanding fundamental analysis versus technical analysis

Fundamental analysis and Technical analysis are two common methodologies used when analyzing any given investment. This article explains Fundamental Analysis vs. Technical Analysis investment methodologies to help you better understand how and when each is used.

Fundamental Analysis

Fundamental analysis is the approach whereby one tries to calculate the intrinsic value of a given stock by looking at the basic economic factors, the fundamentals which would impact its value. Some of the factors that will be looked at include:

• Growth prospects for the company.
• The competitive factors the company faces.
• Revenues, expenses and income.
• Expected return on equity or assets in the industry.

The main goal of this analysis is to establish a value for the stock that would factor in all of these underlying factors. This is considered as a long-term investment approach as it doesn’t look at the short-term pricing and trading swings. This methodology is considered to build a valuation based on backward and forward-looking information.

Technical Analysis

This is an investment methodology that evaluates investments purely on the market activity surrounding them, and doesn’t  look into the actual operations or value of the company itself. Some of the factors that are looked at include:

• Trading volumes over time.
• Historical Pricing of the shares.
• Industry trading trends.

This methodology tends to capitalize on pricing opportunities and trends that can be identified in the market activity around each share. Since this methodology is purely based on historical market activity, it is considered a backward looking methodology.

Fundamental Analysis vs. Technical Analysis

Key Factors to be considered when choosing a methodology between the two:

• • Time horizon – 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 considered to be short-term focused. 
  • Investment Approach – Are you an investor or a trader? Fundamental analysis is investing in companies and relying on their underlying value to drive your return while Technical Analysis is like a trading strategy where you are aiming to drive returns out of identified trends and opportunities.

Bottom Line

Though major funds invest millions of dollars in sophisticated technical analysis trading software, the average investor will likely be far better served if he/she just focuses on fundamental analysis investment strategy.

Related: Key investment principles revealed by Warren Buffett