Fundamental analysis vs technical analysis. These are two approaches to forecasting and researching future stock prices, but they are quite different. Fundamental analysis focuses on the meat and potatoes of a company: revenue, profit margins, sales growth, and debt levels. Technical analysis is all about charts, charts, charts. Of course, this is an oversimplification of both types of analysis. Today, we’ll dig a little deeper into each type and determine which is best (hint: it depends on the type of investing you want to do).
Fundamental analysis is the study of the intrinsic value of an operating business. When you hear analysts discuss a company’s profit margins, earnings, or sales growth, they’re utilizing fundamental analysis to judge the potential of a company’s stock.
The study of a company’s fundamentals is inherently forward looking. Fundamental analysts listen to conference calls during earnings reports for information about guidance, projections, and other statements about future expectations. Analysts using fundamental factors will also look at the sector or the economy as a whole when coming to conclusions about an individual company.
Fundamental analysts also look for the intrinsic value of a firm because they seek to silence the short-term noise of stock price gyrations. Where the stock price is 5 days from now is of little concern for these analysts – they want to know how the company will fare over the next 5-10 years.
- Revenue: A company has to make money in order to be successful, right? Fundamental analysis takes a hard look at revenue and the expected growth a company might achieve in the future. A company that increases its revenue growth rate annually will be on the radar of fundamental analysts.
- Margins: If revenue is the amount of money a company takes in, margins are the costs endured by that company in order to produce, market, and sell its product. If a company spends too much money developing and selling its product, gains in revenue will be offset by increasingly high costs of goods sold. Unfavorable margins can doom even the most anticipated goods and services.
- Price Ratios: Factors like Price to Earnings and Price to Book ratios help measure a company’s stock price in comparison to its intrinsic value. While many of the standards of these ratios need to be updated (PE ratios over 20 are no longer bad news!), it does help gauge whether a company’s stock price is getting too far ahead of the underlying business.
In his seminal book Random Walk Down Wall Street, veteran investor and professor Burton Malkiel described technical analysis in the same vein as witchcraft, astrology, and palm reading. Many fundamental analysts view short-term stock price moves as utter randomness, completely disengaged from real world values and business affairs. But technical analysts view the past as a prologue and they look for patterns and trends that repeat.
Technical analysis is the study of past price data through charts. By examining previous price movements, technical traders believe they can anticipate future changes in trend or momentum by looking for a few key factors. If fundamental analysts are buy-and-hold investors, technical analysts are short-term traders who don’t really concern themselves with the underlying company itself. They’re more concerned with how the pool of traders in the market will react to a particular stock.
- Support and Resistance: On a stock chart, price points tend to hover around certain areas known as support and resistance. When looking at prices, the support level will be an area where buyers seem to converge and prevent the stock from falling further. The opposite is true of resistance – it’s a price point where sellers seem to be consistently exiting their position. Support and resistance are concepts utilized by technical traders looking for entry and exit points for their trades.
- Moving Averages: Price data can be messy and random, even technical traders know that. That’s why they’ve developed moving averages to help smooth out price data and eliminate bouts of randomness. Using time frames of 10, 20, 50, or 200 days allow traders to get a better sense of a stock’s overall trend while ignoring the noise of outlying prices.
- Volume: One of the most important factors in any technical trading analysis is volume. Volume refers to the amount of shares being traded within a particular time frame, and an increase or decrease in volume is often used to confirm technical trend signals.
Regardless of which type of investor you are, you don’t need to pick a side when it comes to technical vs fundamental analysis. Both can be used effectively within the proper time frames if you understand the concepts. Short-term traders don’t have time to let sales and revenue growth develop over a period of years, while long-term traders care more about the overall health of the company then where the stock is headed next month. Using both isn’t a cardinal investing sin – just be sure your goals, risk tolerance, and time horizon match with the trade you want to make.
Work With an Experienced Financial Advisor
They are different ways to analyze and forecast stock prices and it can be difficult to get into investing alone if you’re not sure where to start. If you’d like to learn more or need assistance creating a financial plan that suits your needs, contact the team at Good Life of Mount Pleasant today.
The opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual.
Stock investing includes risks, including fluctuating prices and loss of principal.
No strategy assures success or protects against loss.