Fundamental analysis and technical analysis are two different directions of thinking when it comes to the financial market. Technical Analysis looks at the technical aspects of a stock such as price movements, trends, and price actions, and uses this data to predict future price movements.
Fundamental analysis looks at the fundamental level of a stock such as its economic aspects, and financial factors that influences the business, and tries to predict how the price will be at a future point in time.
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Combining Fundamental and Technical Analysis
Let’s look at these two approaches in detail and how we can combine both to get a better result while analyzing a stock.
The process of evaluating securities/stocks through statistics is known as technical analysis. The goal of technical analysis is to evaluate data- such as historical returns, price changes, and chart patterns that can be used to estimate future price movement for that particular stock or the market as a whole.
Technical analysis uses data from short periods of time to develop the patterns used to predict securities or market movement. Because of the short duration of data collection in technical analysis, investors tend to use this method more in short-term trading.
It is based on the premise that the price of a share moves in trends, i.e., upward or downward, relying upon the attitude, psychology, and emotion of the traders. Technical analysis is able to tell you when to enter or exit the stock.
Tools used for Technical Analysis
Prices: The change in the price of securities is represented in the change in the attitude of the investor and the demand and supply of securities.
Time: The degree of price movement is a function of time, i.e., the time taken in the reversal of trend will determine the change in price.
Volume: The magnitude of price changes can be seen in the transaction volume that characterizes the change. Suppose there is a change in the price of shares, but there is a small change in the transaction volume, then it can be said that the change is not very powerful.
The majority of investors who want to evaluate long-term investment decisions start with a fundamental analysis of a company, an individual stock, or the market as a whole. Fundamental analysis is the process of measuring a stock’s intrinsic value which is a measure of what an asset/company/stock is worth. This is done by evaluating all aspects such as reviewing economic factors, including the overall strength of the economy and specific industry sector conditions.
Tangible assets, including the land, equipment, or buildings that a company owns, are reviewed in combination with intangible assets such as trademarks, patents, branding, or intellectual property.
To perform fundamental analysis, you'll want to review a company's financial statements, historical data, investor conference calls, press releases, analyst reports, and analyst estimates.
Investors then use these results to conclude whether a long-term investment is worth buying because it is undervalued or if it is worth selling because it is overvalued. This investing technique is adopted by the buy-and-hold strategy.
Fundamentally focused investors often wait a long time before a company’s intrinsic value is reflected in the market, if at all. Part of the reason that fundamental analysts use a long-term timeframe is that the data they use to analyze a stock is generated much more slowly than the price and volume data used by technical analysts.
A typical fundamental analyst performs this analysis:
Qualitative and Quantitative Analysis
When you fundamentally analyze a company, you can either analyze it by qualitative analysis or quantitative analysis. One needs to do both of these to completely understand a company.
Quantitative analysis mostly deals with financial performance or other business metrics. For this, we require certain data sources or inputs about the company. The most common data sources are: -
Balance Sheet &
Cash Flow Statement
The qualitative analysis deals with the analysis of qualitative characteristics of the company, which are highly subjective in nature. For instance, the quality of management, corporate governance practices, ethics, reputation in the market, brand value, consistency of business strategies, etc. The most common source is the “Management Discussion and Analysis” section of the Annual Report.
Combining Fundamental and Technical Analysis
When you’re into trading, you need to find fundamentally good stocks to trade. Else, due to the low stability of the stock, the prices can be highly volatile giving you bad trades. Having a point of view on news, and market sentiments help traders to be informed about the trends that are going on in the market. Fundamentally performing stock doesn’t have high volatility compared to other stocks.
How do you choose the right time to invest in a stock? That is where technical charts come into play. By understanding the technical charts of a company, you as an investor can spot the best possible time to buy the stock.
If you invest in an unlisted company, fundamental analysis is all you have available to work with. But, when it comes to listed stocks, you have technical analysis also in front of you.
If you’re a trader, you will be more concentrated on the technical analysis of a stock. If you’re an investor you are more into fundamental analysis of a stock. Either way, depending on your trading/investing style, your risk appetite, your circle of competence, etc. it is you who should choose the best style.