6.6 Difference between technical analysis & fundamental analysis

TECHNICAL ANALYSIS VERSUS FUNDAMENTAL ANALYSIS

In its most simple way, fundamental analysis tells you whether a stock is a good stock or not. And technical analysis evaluates the historical prices of stock and gives you an idea about when is it the right time to buy and the right time to sell. Fundamental analysis is the primary analysis required for understanding a stock’s value and picking up the stock whereas technical analysis is useful in understanding the timing to buy a stock. Fundamentals are all those factors that affect the supply and demand of the underlying commodity. For example, if you were analysing the price of wheat and you thought that the price of wheat was going to go up because of a drought in the northern states of India, you would be structuring your analysis of the wheat market on such fundamentals.

Technical analysis, on the other hand, is a study of the market based on a chart of its price data. If you were to look at the chart of the price of wheat over a particular time period and saw that the price of wheat now is the lowest in 20 years, then you are said to be using technical analysis. You do not need to know anything about the underlying commodity to be a technical analyst and that is one of its advantages. If you wanted to study the fundamentals of coffee, then you would want to know everything about coffee: how it is grown, what are its planting cycles, who are the big buyers of coffee, what are their plans in the future, how would that affect the demand for coffee and so on. The problem in researching coffee, or any such product, is that it takes a very long time to find out this information and then even more time to examine and interpret it.

Technical analysts claim that all the fundamentals or things that affect the price of a commodity are indicated on the price chart anyway. This actually makes sense if we think about it in terms of the laws of supply and demand.

If the supply of coffee goes up and the demand stays the same then the price will go down. This supply and demand relationship can be seen as a price drop on a price chart. In stock investment these are the two different stock-picking methodologies used for researching and forecasting the future growth trends of stocks. Like any investment strategy or philosophy, both have their advocates and adversaries. Here are the defining principles of each of these methods of stock analysis:

  • Fundamental analysis is a method of evaluating securities by attempting to measure the intrinsic value of a stock. Fundamental analysts study everything from the overall economy and industry conditions to the financial condition and management of companies.
  • Technical analysis is the evaluation of securities by means of studying statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security’s intrinsic value but instead use stock charts to identify patterns and trends that may suggest what a stock will do in the future.

Though the objectives of both analytical tools i.e. fundamental analysis and technical analysis is to pick up the stock for maximizing the returns- their approaches and focus areas differ. Following are the differentiating factors for the two forms of equity analysis.

Fundamental Analysis Technical Analysis
Estimate intrinsic value Estimate trend value
Value decision Timely decision
Primary or Basic analysis Supplementary analysis
Operating performance, financials as its major inputs. Company's share price as its major input.
Time consuming Can be done in less time (Instantly)
Depends on first hand information or primary data Depends on price information
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