Fundamental Analysis vs Technical Analysis
We're going to look at fundamental analysis versus technical analysis. We're going to discuss each of them, compare and contrast the two methods and also investigate some of the pros and cons. So let's get into the details of fundamental analysis versus technical analysis. But both ways of trying to tackle a question that's always of interest to investors which is whether a company is cheap or whether it's expensive. Really they come at the problem from different directions. Fundamental analysis and technical analysis are not methods that are restricted to investing in shares. They used by lots of different types of traders and they all use fundamental analysis or technical analysis or maybe a combination of the two in different ways. But for this chapter I'm approaching their methods from the perspective of an equity investor. Let's start with fundamental analysis. Fundamental analysis takes the view that it's economic forces that drive prices, so why not investigate the economic nuts-and-bolts of a company in order to work out whether it's cheap, whether it's expensive or whether it's the right value. So let's look at this in detail. With fundamental analysis we're using available data to gauge a shares value taking the time to evaluate; all the information available, anything that's out there that affects the company economically. This can come in the form of quantitative information or qualitative information. Quantitative means the hard numbers. Things that can actually be counted as the name suggests; it's to do with quantity. Whereas qualitative is all the stuff that can't be measured numerically; the intangibles as the name suggests. This is to do with quality of the company; the essence of character. So let's look at some examples to further illustrate these two terms. Some examples of qualitative information is brand value, brand recognition, the management of the company; the people who are actually running it; what their track record is and what they have to say about where the company's going. Then some examples of quantitative information is dividends, earnings, sales or book value. Then we can actually compare these pieces of information to price with what we call valuation ratios; a price to earnings, price to sales and price to book value. For both quantitative and qualitative information; these together help us learn more about the financial health of a company and its prospects for growth going forward. In contrast, technical analysis says all those things that fundamental analysis is worried about; things like dividends, earnings and who's running the company. We don't need to worry about those separately because what we're going to assume is that all those things are already reflected in the price. So let's just look at what price has been doing.
As we said technical analysis assumes it's all in the price. Therefore a technical analysis purist might say that effectively everything they need to know is in the charts. At a basic level just a chart by itself does offer a visual summary of what a stock has been doing. That tells you a lot more than just staring at price tables but beyond this, we have this concept that looking at historical price data, can be a guide to the future what has happened before. It might tell us a little bit about what is yet to come. When we talk about looking at what price is doing and has been doing recently, this is what we refer to as price action. Some key concepts here are support and resistance, trends and trend lines price breakouts. Alongside recognizing price action we have a host of technical the cases available like moving averages, isolators and measures of volatility. By volatility we mean how much price has been moving. Price action and technical indicators are just looking at price charts with no recourse to the fundamentals. Now that we've covered fundamental analysis and technical analysis let's take a dive into whether there are any benefits or any drawbacks from using the two different methods. With fundamental analysis one of the key assumptions is that the price will reflect fundamentals in the long run and investors relying on fundamentals. They see that a company is undervalued and therefore buying shares in the company due to it's data that will in time increase in value but we don't know when. It tells us nothing about the timing or when this eventually going to happen so it’s a drawback. Also because there is so much fundamental information available such as financial statements, balance sheets or announcements; so to stay on top of it for one company, it takes quite a chunk of time. To do it effectively, you have to look at lots of companies continuously. Thus fundamental analysis is time-consuming while technical analysis looks at things from a different direction to fundamental analysis whereas fundamental analysis looks at economic factors and driving price. Technical analysis can clue us in to sentiment and speculation that fundamental analysis doesn't look at.
We can also use our technical tools to gain trading signals and therefore inform our timing for an investment. Fundamental analysis might tell us a crypto is undervalued and therefore we know we want to buy it, but technical analysis might be able to help us find an optimal time to buy it. Is one method better than the other? Well, it doesn't have to be an either/or situation. A lot of investors and traders do tend to use a combination of both, even if they lean heavily in favor of one over the other. Even someone who's heavily in favor of technical analysis is unlikely to ignore if a CEO has left a company or if the earnings are extremely weak. Looking at it the other way someone who is heavily in favor of fundamental analysis is probably still going to cast their eye over a chart just to get a feel for what the company's price has been doing. From my own personal perspective I want to use all the tools that are available so if there is any benefits were age to be gained from one of the tools, why not use it. Also the longer term investor is more likely to lean on fundamental analysis and taking that to an extreme a fund manager who's dealing in investments they're going to last years and years might not use technical analysis at all. Instead purely base their decisions on fundamental analysis. While short term traders might lean heavily on technical analysis only. But which tools to use? Well a TA Purist or technical analysis purist is generally using technical analysis 100%. Next someone we would call a heavy technician might make most of their decisions using technical analysis but keep an eye on things like earning reports or pay attention to major macroeconomic releases so would use technical analysis around 75% of the time. Next we have someone we call an Ambitrader who would look at both fundamentals and the technical, so 50/50. Maybe they use technical analysis to confirm the decisions they're making from looking at the fundamentals or maybe they use technical analysis as a way to time their entries and exits after deciding what to do based on the fundamentals. Next we have someone called a casual Chartist who heavily focuses on fundamental analysis but might cast their eye over a chart every now and then so these people would rather look at 25% of technical and 75% fundamentals. Lastly we have the Warren Buffett types of people who would purely look at fundamentals 100%. One might describe these people more like investor rather than traders however this doesn't necessarily have to be the case. Ultimately, it's up to the individual. The golden rule is to use what works for you well.
