When it comes to analysing the financial markets there are two primary approaches used. One is technical analysis and the other is fundamental analysis, and they are quite different in their approaches. Both have their advocates and opponents and some traders combine both for the most accurate forecasting.
Fundamental analysis tries to determine whether the price of an asset is too high, too low, or just right by attempting to find the intrinsic value of that asset. Fundamental analysis looks at the broader picture, taking into account everything from the overall economy to the strength of individual managers involved with the asset. When using fundamental analysis on stocks, all the financial specifics of the company come into play as part of the analysis.
Technical analysis avoids looking at the earnings or economics behind an asset and instead, it focuses on the price action and statistical trends over time. Technical analysts believe that there is no reason to look at fundamentals because they are already priced into any asset. Instead, they examine the patterns and trends in the movement of the asset’s price, believing they have predictive value for what the price will do in the future.
The differences between fundamental and technical analysis are many and varied, but in essence, it comes down to what it is that actually determines the price of an asset. Fundamental analysis concerns itself with the actual price of the asset versus what it should be worth.
By contrast, technical analysis avoids any fundamental considerations and focuses wholly on price action, believing this has predictive value over the stock. The patterns seen on charts often repeat and technical analysis looks to identify these patterns as they are being formed.
Fundamental Analysis Advantages
Analysing an asset based on its economic and financial position does give several advantages. Focusing on the value of the asset without considering what the current price is, can allow a trader to find the real value of the asset. This is particularly valuable for long-term investing. Fundamental analysis is also very good at locating assets that are being heavily under or over-valued by the markets. Also, over the long-term fundamental analysis has been found to be more accurate in predicting future prices.
Technical Analysis Advantages
Technical analysis allows for more rapid analysis of an asset and some tasks can be automated to save trader’s time. Technical analysis is also very handy for determining short term price targets and levels with very clearly defined risk and reward profiles. Short term price moves often occur that fundamental analysis is incapable of finding, but technical analysis can easily spot the moves. Plus, technical analysis is quite good at determining market sentiment and psychology and the flow of supply and demand in an asset. With technical analysis a trader can find strategies that are more appropriate given the current market conditions.
Fundamental Analysis Disadvantages
Like anything, there are also disadvantages to using fundamental analysis. For starters, it is quite time consuming, meaning traders will be limited in the number of assets they can consider for investment. Plus, the data used in fundamental analysis is widely available, which makes it difficult to gain an edge using fundamentals alone.
You’ll learn very little about the short-term movements of an asset by using fundamental analysis and the findings are often quite general and not as precise as you might hope for. Also, the valuation models used in fundamental analysis rarely lead to accurate price predictions.
Technical Analysis Disadvantages
Technical analysis also has its disadvantages. Chief among them, is that many forms of technical analysis are subjective and rely on the judgment of the individual trader. Technical analysis is often as much art as it is science. Another drawback is that technical analysis often delivers ambiguous results. Two technical analysts will often come to different conclusions regarding the same asset when using different approaches or time frames. And because there are so many tools and indicators it can be difficult to decide which ones to use.