Difference between Fundamental Analysis vs Technical Analysis in Stock Market

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There is no sure shot way to predict the markets. No methodology for understanding markets has ever given a 100 percent success rate. Each methodology has its flaws in different types of market conditions. As a stock market advisor or a trader, you need to understand as to which research method is likely to be least flawed in a given circumstance. This method will have the highest probability of accurate recommendation.

So the question arises? Which research method is right for which type or trader?

There are several factors which need to be accounted for to answer this. If you are a day trader looking to earn money from the momentum in the markets, then, technical analysis would be best suited for you. However, if you are among those investors who want to punch in their trades and forget for a long period of time, then, fundamental analysis is what you might need.

Let us understand the features, pros and cons of fundamental and technical analysis.

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What is Fundamental Analysis?

Fundamental analysis is the method of evaluating a stock on the basis of its financial strength and stability, with the aim to find out the intrinsic or fair market value of the stock. Fundamental analysis believes that stock prices always gravitate towards the fair market value of the stock, which is calculated using fundamental analysis. So, according to fundamental analysis, if the stock prices are trading above their fair value, they would move soon move down, and try to reach its fair value. On the other hand, if a stock price is trading below its fair market value price, then, the stock is  ‘undervalued’ and its stock prices will go up.

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What is Technical Analysis?

Technical analysis is the method of analyzing the price movement of a particular stock or any trading instrument, irrespective of its fundamentals or financials, solely on the basis of volume and trends seen in the movement of the security’s price. Technical analysis believes that history repeats itself and do not give any major importance to the fundamental position or the economic strength of the company.

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Difference Between Technical and Fundamental Analysis?

1. On the Basis of Approach:

While fundamental analysis, tries to find our gaps in the company’s intrinsic value and its market value technical analysis tries to find out patterns in its price carts, believing that patterns repeat themselves as investors behave identically in a particular set circumstance.

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2. On the Basis of Factors Assessed:

Fundamental analysis depends on a company’s financial assets, liabilities, profitability, etc, and technical analysis depends on the demand and supply balance for the company’s outstanding stocks and shares which ultimately impacts its stock price.

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3. On the Basis of Tools Used:

Financial statements, balance sheets, income statements, cash flow statements, annual reports, major announcements, EPS ratio, PB ratio, corporate news, assets inventories etc. are the tools which are used by fundamental analysts to determine the company’s value. On the other hand, candlestick charts, momentum indicators, moving averages, patterns, oscillators, Elliot waves etc. are the tools which are used by technical analysts to recommend trades.

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4. On the Basis of Time Frame of Recommendations:

Fundamental analysis is often used for recommending trades for a medium to long term as factors such as company’s financial health, profitability etc. do not change overnight or within shorter time durations such as minutes and hours. Technical analysis on the other hand is primarily used for shorter duration trades as is tracks patterns formed on a minute by minute basis. Technical analysis aims to track these short term patterns and generate recommendations on the basis of these.

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Pros and Cons of Fundamental Analysis

The advantage of performing a fundamental analysis of a company is that it gives the investors an idea of what the company is actually worth. Fundamental analysis is useful for investors to understand whether their holdings are at a risk or not, something which technical analysis cannot really predict. Fundamental analysis if done properly helps investors generate wealth over a long term. It gives the investors the right information about when the markets are overvalued and at risk of a potential downturn.

However, on the downside, fundamental analysis cannot help investors make money from the daily price fluctuations and volatility in the markets. Another disadvantage of fundamental analysis is that it is often more time consuming that its counterparts.

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Pros and Cons of Technical Analysis

Technical analysis has many benefits to its side, the first one being that it can be done quickly by identifying patterns in the price charts which indicate beginning for a trend or a reversal. Technical analysis can be used to find earning opportunities on an hourly and daily basis, taking advantage of the volatility in the prices.

Another benefit of technical analysis is that it can provide opportunities to intraday traders to participate in the markets, unlike fundamental analysis.

On the downside, technical analysis is rarely helpful when it comes to long term investors. Also, technical charts can be interpreted by different analysts differently. Hence, there can be a divergence in the recommendation given by two analysts regarding the same chart.

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Conclusion

Technical and fundamental analyses have their own sets of pros and cons. The best strategy is to identify the needs of the investors and on the basis of the need a particular method of analysis should be chosen.

You can also choose to use both methods simultaneously, to build your own watch list. When the signals generated by the technical and fundamental analysis match, you can enter the trade and take position to earn profits. Fundamental analysis can help you understand the business cycle of a company and a technical analysis can then validate this data and provide earning opportunities, thus working in tandem to achieve the goal of profit making trades.

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