Fundamental & Technical Analysis Mini Course by Colin Nicholson
Description
Technical analysis and fundamental analysis are the two main schools of thought in the financial markets. As we mentioned, technical analysis looks at the price movement of a security and uses that data to predict its future price movements. Fundamental analysis, on the other hand, looks at economic factors known to be fundamental. Let’s take a closer look at how these two approaches differ, critiques of technical analysis, and how technical and fundamental analysis can be used together to analyze securities.
DIFFERENCE
CHARTS AND FINANCIAL STATEMENTS
At the most basic level, a technical analyst approaches a security from charts, while a fundamental analyst starts from financial statements. (For further reading, see the introduction to fundamental analysis and advanced analysis of financial statements.)
By looking at the balance sheet, cash flow statement, and income statement, the fundamental analyst tries to determine the value of the company. From a financial point of view, the analyst tries to measure the intrinsic value of the company. With this approach, investment decisions are fairly easy to make – if the price of a stock is trading below its intrinsic value, it is a good investment. While this is an oversimplification (fundamental analysis goes beyond financial reporting only) for the purposes of this guide, this simple principle remains true.
Technical traders, on the other hand, believe that there is no reason to analyze a company’s fundamentals because they are all factored into the stock price. The specialists believe that all the information they need about a stock can be found on its charts.
TIME HORIZON
Fundamental analysis takes a relatively long-term approach to market analysis as compared to technical analysis. While technical analysis can be used on a timeframe of weeks, days, or even minutes, fundamental analysis often looks at data over several years.
The different time frames used by the two approaches are a result of the nature of the investing style they follow. It can take a long time for a company’s value to be reflected in the market, so when a fundamental analyst estimates intrinsic value, profits are not realized until the market price of the stock rises to its “correct” value. This type of investing is called value investing and assumes that the short term market is wrong, but that the price of a particular stock will correct in the long run. In some cases, this “long term” can be a time frame of several years. (For more information, read Warren Buffett: How Does He Do It and What Is Warren Buffett’s Investment Style?)
Moreover, the figures that the fundamentalist analyzes are only published for a long period of time. Financial statements are submitted quarterly and changes in earnings per share do not appear on a daily basis like price and volume information. Also remember that the fundamentals are the actual characteristics of the business. New leadership cannot make drastic changes overnight and it takes time to create new products, marketing campaigns, supply chains, etc. One of the reasons fundamental analysts use a long-term timeframe is because the data they use for stock analysis are generated much more slowly than the price and volume data used by technical analysts.
TRADE AGAINST INVESTMENT
Not only is technical analysis more short-term in nature than fundamental analysis, but the goals of buying (or selling) stocks are usually different for each approach. Typically, technical analysis is used for trading, while fundamental analysis is used for making investments. Investors buy assets that they think might rise in value, while traders buy assets that they think they can sell to someone else at a higher price. The line between trade and investment may be blurry, but it characterizes the difference between the two schools.
CRITIC
Some critics view technical analysis as a form of black magic. Don’t be surprised if they question the discipline’s validity to the point that they scoff at its supporters. In fact, technical analysis has only recently begun to enjoy some mainstream confidence. While most Wall Street analysts are focused on the fundamental side, almost every major brokerage business now uses technical analysts as well.
Much of the criticism of technical analysis has its roots in academic theory – in particular, the efficient market hypothesis (EMH). This theory says that the market price is always correct – any past trading information is already reflected in the stock price, and therefore any analysis to find undervalued securities is useless.
There are three versions of EMG. In the first, called the weak form of efficiency, all past price information is already included in the current price. Due to poor form effectiveness, technical analysis cannot predict future movements because all past information has already been taken into account, and therefore analysis of the stock’s past price movements will not give any idea of its future movements. In the second, semi-strong form of efficiency, fundamental analysis also claims to be of little use in finding investment opportunities. The third is the strong effectiveness of the form, which claims that all information in the market is factored into the stock price, and neither technical nor fundamental analysis can give investors an edge. The overwhelming majority of scholars believe in at least a weak version of EMH, so from their point of view, if the technical analysis works, the effectiveness of the market will be questioned. (For more information, read What is Market Efficiency? And Developing the Efficient Market Hypothesis.)
There is no right answer to the question who is right. There are arguments to be made from both sides, and therefore, it is up to you to do your homework and define your own philosophy.
CAN THEY COEXIST?
Although technical analysis and fundamental analysis are viewed by many as polar opposites – oil and water investing – many market participants have experienced great success combining the two. For example, some fundamental analysts use technical analysis techniques to determine the best time to enter an undervalued security. This situation often occurs when a security is heavily oversold. By entering the security on time, the return on investment can be greatly improved.
Alternatively, some technical traders may look at fundamentals to add strength to the technical signal. For example, if a sell signal is given through technical patterns and indicators, a technical trader might try to confirm his decision by looking at some key fundamental data. Often, having both fundamental and technical data on your side can provide the best trading scenario.
While the confusion of some of the components of technical and fundamental analysis is not well received by the most dedicated groups in each school, there are certainly advantages, at least for understanding both schools of thought.
In the following sections, we will take a closer look at technical analysis.
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Course Features
- Lectures 0
- Quizzes 0
- Duration Lifetime access
- Skill level All levels
- Language English
- Students 183
- Assessments Yes
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