Fundamental vs technical analysis has been a long-standing debate among investors and traders. It also causes significant difficulty for new participants of financial markets to select between the two. It is not surprising as these are the only two active-management strategies that are available. It took me 15 years of investing and trading in various financial markets to confirm the effectiveness of fundamental and technical analysis. As preparation of the financial statement is one of the core arguments in the debate, having spent more than ten years in the accounting industry does help. It allows me to differentiate between the facts and myths about the financial figures on the financial statements that move the asset prices.
These are the six commonly asked questions on fundamental vs technical analysis topic that I will answer in this article.
- Why do you need to know the difference between fundamental vs technical analysis?
- What is fundamental analysis?
- What are the advantages and disadvantages of using fundamental analysis?
- What is technical analysis?
- What are the advantages and disadvantages of using technical analysis?
- Fundamental vs technical analysis, which is more effective?
1. Why do you need to know the difference between fundamental vs technical analysis?
As I have shared in an article on investment, there are four steps in successful investing. After you have decided on the investment objective, selected the suitable market and instrument, the last step is to choose the right strategy. The effectiveness of fundamental and technical analysis will depend on the combination of choices made in the first three steps.
For example, if you would like to invest in equity using cash, adopting fundamental analysis will give a much higher chance of success than using technical analysis. On the other hand, if you prefer to trade a commodity using futures, technical analysis will likely be a much better option.
You have now understood the importance of choosing the right strategy to enter the financial market. We can then proceed to look at what fundamental analysis is all about.
2. What is fundamental analysis?
Fundamental analysis is an investment strategy that analyses various information about economics, industry and company to determine the intrinsic value of an asset. An investor can then decide whether to buy, hold or sell an asset by comparing its perceived price against the current market price.
For example, if the perceived price of an asset is $5. However, the market price is currently trading at $3. That means that it is selling $2 below what it is worth. An investor may then decide to buy and wait for the price to correct itself to $5. On the other hand, if the market price is currently trading at $7. An investor who is holding the asset may decide to sell due to overvaluation.
At the core of the fundamental analysis is the financial statement analysis. It is the skills in reading financial statements. We will then compute various financial ratios to determine whether it is worth investing in a particular company. Accountants have the responsibility to prepare financial statements. The board of directors will then approve and issue them to the public.
3. What are the advantages and disadvantages of using fundamental analysis?
The process of fundamental analysis may involve assessing the economics of a country, potential growth of industry and competitiveness of a company. Analysts spend much of their time reading financial statements to evaluate if it is worth investing in a particular company. Unlike smaller setups, all public listed companies must engage auditors to audit their financial statements. Therefore, one of the main advantages of using fundamental analysis is it relies on a reliable source of information.
As there is a plethora of data available, fundamental analysis can be very time-consuming. Another disadvantage of this strategy is that the financial statements of a company can be very complex. It requires a certain level of accounting knowledge to decipher the information in it.
Due to the drawbacks of fundamental analysis, technical analysis flourishes. The technological advancement in recent decades has also made technical analysis available to wider audiences.
4. What is technical analysis?
Technical analysis is an investment strategy that analyses the balance between the supply and demand of a financial asset. It relies mainly on the price. Occasionally, technicians use volume in their assessment.
The primary tool which technicians use is a chart. All technicians need to master the skills of chart reading. The most widely used chart type is the candlestick chart. It contains information such as the high, low, opening and closing price of various time frames.
Technical analysis may also use indicators. Each different investor has its own set of preferred indicators. While a technical analysis may look easy, it comes with its challenges too.
5. What are the advantages and disadvantages of using technical analysis?
Due to its ability to “time the market,” technical analysis is commonly used for trading purpose. The ease of using a chart to forecast future price is the main reason for its popularity. As the chart contains all the information required for decision making, technical analysis may appear to be easier to put into practice.
Technical analysis gains popularity among those who believe the financial statements may not all information about a company. On the other hand, they feel that the price resembles all the relevant information. Such investors may also claim that the data in the financial statements contain past data that may not be reflective of future performance.
One main drawback of technical analysis is that it takes a long time to master. Most traders would have given up before they reach the level of mastery required.
6. Fundamental vs technical analysis, which is more effective?
I hope you have a better understanding of the difference between fundamental and technical analysis now. So, which one should you learn and adopt then? The answer will depend on your objective to participate in the financial markets. If you have decided to invest for the long-term, fundamental analysis should be your primary strategy. On the other hand, should you choose to trade for a living, you need to master technical analysis.
The two investment strategies are not mutually exclusive. Investors or traders may use a combination of both. I use both of them when entering the markets. Using both investment strategies allow me to have the overall picture. It is a little like driving with both a windscreen and a rearview mirror.
Final Words
I have attempted to make this article on fundamental vs technical analysis to be as comprehensive as possible. However, do drop me a comment should there be any crucial areas I may have missed. Do let me know should there be certain concepts that you may want to know as well. Thank you for hanging around here. I shall see you in the following article!
Written by Yanto Wong
