Fundamental vs. Technical Analysis

Instructor: Michelle Reichartz

Michelle has lead multiple training initiatives and has a master's degree in Business Administration.

In this lesson you will learn what fundamental and technical analysis is, the difference between the two strategies, the pitfalls for each strategy, and how to determine which is best for you.

Picking a Strategy

Think about a basketball game in which you are the coach. You have a great set of players, but they have a set of weaknesses. They don't work well together, but are fantastic on their own. The game you are about to play is very important as it could be the difference between you ending the season or going into the playoffs. You have two strategies you can use: man to man or a zone defense. Each one has its own benefits, but which is best for you? How can you know that the strategy you go with will lead to the biggest reward?

It is this same thought process that can be applied to the investment world when it comes to the debate between fundamental versus technical analysis.

Fundamental and Technical Analysis Defined

First, it is important to understand the basics of fundamental and technical analysis, and how they are similar and different.

Fundamental analysis is a method of evaluating securities by calculating its intrinsic or true value. It analyzes the factors that may affect the price in the future, such as financial data, industry trends, competitor's performance, and the status of the economy.

Technical analysis looks at the statistics of a stock's market activity in order to determine its potential direction in the future. It uses the past price pattern in order to predict that future movement.

Understanding the Difference

Fundamental and technical analysis are different ways to look at a stock or security. While fundamental analysis takes a long-term approach to investing, technical analysis takes a short-term approach. Fundamental analysis uses the return on equity ratio or the return on assets ratio in order to evaluate a security. Technical analysis uses a very different approach, instead using market theory and past price data to evaluate a stock. Technical analysis really focuses on when to buy into a stock or when it is best to sell a stock while fundamental analysis attempts to find the value of a stock.

In short: fundamental and technical analysis live on opposite sides of the investment analysis strategy pool.

Pitfalls of Each Strategy

There are multiple options when picking the type of analysis to use because each strategy has weaknesses.

Fundamental analysis assumes the following:

  • The stock price will correct itself in time
  • You can profit by buying undervalued stock and then selling it when market corrects itself
  • The success of a stock can typically be calculated by using the past and present financial and economic information

The problem with fundamental analysis is that not all stocks can use calculations to determine what will profit. The economy can be unpredictable and companies sometimes run into unexpected situations. These factors cannot always be avoided and in many cases, can take you by surprise. In addition, the vast amount of information needed to confirm which stocks are the best choices can be time consuming.

Technical analysis involves the following:

  • Ignoring the foundation information behind a stock
  • Too many indicators used can lead to confusing results
  • Trend in price typically repeats itself

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