Table of Contents:-
- Difference Between Fundamental Analysis and Technical Analysis
- Fundamental Analysis vs Technical Analysis
- Key differences between Fundamental Analysis and Technical Analysis
- What is Fundamental Analysis?
- Objectives of Fundamental Analysis
- Strengths of Fundamental Analysis
- Weaknesses of Fundamental Analysis
- EIC (Economy-Industry-Company) Framework
- What is Technical Analysis?
- Assumptions of Technical Analysis
- Factors Considered in Technical Analysis
- Criticisms of Technical Analysis
- Understanding Price Fluctuations: The Intersection of Fundamental Analysis and Technical Analysis in Stock Markets
Difference Between Fundamental Analysis and Technical Analysis
The difference between fundamental analysis and technical analysis can be understood from the following table:
| Basis of difference | Fundamental Analysis | Technical Analysis |
|---|---|---|
| Perspective | The analyst’s perspective is inherently long-term, marked by a conservative approach in their analysis. They act based on what ought to be. | The analyst’s outlook is short-term oriented, characterized by an aggressive approach. They act based on what currently exists. |
| Policy | He adheres to a buy-and-hold policy, typically not anticipating any significant increase in the value of his investments within a year. | He believes in making a quick profit and frequently seizes investment opportunities by recognizing and forecasting changes in stock prices. |
| Type of gain | The analyst considers that the total gain from equity investment consists of current yield through dividends and long-term gains through capital appreciation. | The analyst does not distinguish between current income and capital gains; he is focused on the short term. |
| Basis of forecasting | He forecasts stock prices based on economic, industry, and company statistics. The principal decision variables take the form of earnings and dividends. He evaluates the stock value with a consideration of risk and return. | Technical analysis is the study of stock exchange information. It involves forecasting security prices by examining supply and demand patterns for securities. |
| Tools for analysis | He uses tools of financial analysis and statistical forecasting techniques. | He uses mainly charts of financial variables besides some quantitative tools. |
Fundamental Analysis vs Technical Analysis
| Fundamental Analysis | Technical Analysis |
|---|---|
| It focuses on the valuation of intrinsic value and, through such valuation, identifies. |
It focuses on timing and potential price changes, not concerned about the intrinsic. |
|
Focus on external factors factors that are outside the market (annual reports). |
Focuses on internal factors factors that are available in the market (price). |
|
The focus is on the long-term expected price. Typically follows a buy-hold-sell strategy. |
Focus is generally on near (short) term changes in the prices through intermediate. |
|
Its focus is on price targets, not generally bothered by short-term price changes. |
Its focus is more on price direction than price target or forecast |
| It requires considerable time for analysis. | It is easier and faster to voluminous data. |
| Difficult to apply for a large number of stocks unless a big analyst team is set up. | Simultaneously applied to many stocks. |
Key differences between Fundamental Analysis and Technical Analysis
Technical analysis often faces criticism as a blind and irrational investment method, while fundamental analysis is considered more scientific and systematic. There is no solid theoretical basis for technical analysis, but that doesn’t make it irrational. Technical analysis operates on a simple philosophy: the market is a place where many investors of different kinds buy and sell securities. It is possible to find patterns in their trading behaviour that can be exploited for buying and selling stocks.
Therefore, it is challenging for anyone to read a textbook on technical analysis and then start implementing it. Successful application requires substantial exposure to the market and an understanding of how a typical crowd behaves when vital information about a company is released. Technical analysts also pay attention to the type of price reaction when insiders enter the stock. Interestingly, technical analysts do not complain against fundamental analysts; instead, they believe fundamental analysis is time-consuming and costly.
What is Fundamental Analysis?
Fundamental analysis is looking at a business at the fundamental financial level. This type of analysis examines key ratios of a business to determine its financial health and gives an idea of the value of the stock.
Fundamental analysts assess the fair market value of equity shares by examining the assets, cash flow projections, earnings prospects, and dividend potential. Fundamental analysts differ from technical analysts we rely on price and volume trends and other market indicators to identify trading opportunities it refers to an examination of the intrinsic worth of the company. Many investors use fundamental analysis alone or with other tools to evaluate stocks for investment purposes. The objective is to determine the current value and more importantly, how the market values the stock. Fundamental analysis has a logical progression from the general to the specific.
Objectives of Fundamental Analysis
Fundamental analysis is performed on historical and present data to make financial forecasts. There are several possible objectives:
1) To calculate its credit risk.
2) It also makes internal business decisions.
3) To protect its business performance.
4) To assess its management and make internal business decisions;
5) To conduct a company stock valuation and forecast its possible price evolution.
6) To screen and categorise stocks and other financial assets in terms of investment quality and expected return, utilizing expectations from the economy and sector groupings to forecast earnings, dividends and intrinsic values of companies.
Strengths of Fundamental Analysis
Fundamental analysis has some key strengths:
1) Understanding of Underlying Business Model: It also helps in understanding the underlying business and business models.
2) Hidden Gems: It is very useful in discovering stocks that may not be well-known, popular or favourites of traders but have high intrinsic value or tremendous potential for growth. Such stocks represent wonderful opportunities for investments which can provide magnificent returns in the long term.
3) Long-Term Trends: Fundamental analysis is also useful for identifying long-term trends – including multi-year and multi-decade trends and capitalising on them.
4) Solid Foundation: This type of analysis is reliant on a thorough understanding of the business and the business model therefore providing a solid foundation for calculating value. The fundamental analysts do not invest in a stock because it is the flavour of the day, but rather because it has the right underlying business model, provides value for money, a high margin of safety, indications of continued robust performance or potential for high growth of the business.
Weaknesses of Fundamental Analysis
However, fundamental analysis also has some weaknesses:
1) Time-Consuming: Analysing so many aspects of the economy, industry or sector and the company can also be very time-consuming. Therefore trading. it is only suitable for long-term investing and not for day
2) Variation in Fair Value: Fair value for the stock can be different for different people and analysts may arrive at diverse valuations. Moreover, valuation norms for different industries and markets vary significantly. Moreover, high-growth companies are valued differently from high-value companies.
3) Detailed Knowledge of Company, Sector and Economy Required: This type of analysis is very involved and specific, and therefore it requires detailed knowledge of the specific business models used. Therefore valuation of a retail company is very different from the economy. Industry and the company and valuation of a pharmaceutical or utility company. Therefore, some fundamental analysts are specialists in tracking and analysing a specific sector or industry as they can cover or understand all the different industries and sectors.
4) Analyst Bias: Analysts can often get attached to specific stocks and lose their objectivity for their favourites. Therefore irrespective of the underlying financials, the analysts may often reach the desired interpretation depending on the stock.
5) Subjective: The interpretation could be subjective different analysts may reach different conclusions based on their understanding, knowledge, expectations and experience with the stock. While the underlying facts and financial statements may be the same, the conclusions reached by analysts may differ significantly. Moreover, fundamental analysts may get too involved with the underlying financials a forget market action. While all analyses may be valid, however, one cannot argue against the Market which may trade against expectations.
EIC (Economy-Industry-Company) Framework
Under the fundamental framework, the types of analysis are undertaken.
1) Economic Analysis: The analyst considers the economic environment, which may give some indication of the future direction of security prices. For example, rising inflation, and interest rates argue that security prices should tend to fall.
2) Industry Analysis: The analyst considers the industry since industries react differently to changes in the economic environment. The demand for durable items, such as cars, major appliances and housing, tends to respond to changes in the level of economic activity, while the demand for other products, such as necessities (e.g., food) and some consumer goods, tends to be less responsive to changes in economic activity.
3) Firm/Company Analysis: After considering the economy and the industry, the analyst considers the individual firm, since what applies to the economy or the industry may not apply to a specific firm. Some films do poorly even when the general economy prospers.
What is Technical Analysis?
Technical analysis attempts to explain and forecast changes in security prices by studying only the market data. In other words, a study of past share price behaviour to predict future trends is termed technical analysis.
Technical analysis is also frequently used as a fundamental analysis. The spirit of technical analysis is reloaded in the following quotation.
Assigning an intrinsic value to a stock certificate is futile. The wide divergence between presumed and actual values is not the exception but the rule. It is going on all the time. Of course, the static, which the fundamentalists study, plays a part in the supply and demand equation that is freely admitted. But many other factors affect it.
The market price reflects not only the differing fears and guesses and moods, rational and rational of hundreds of potential buyers and sellers as well as their needs and their resources in total factor which defy analysis and for which no static’s are obtainable, but which are nevertheless all synthesized, weighted and finally expressed in one precise figure at which a buyer and seller get together and make a deal (through their agents their respective brokers). This is the only concept that matters.
In brief, the going price established by the market itself comprehends all the fundamental information that the statistical analysts can hope to learn (plus some which are perhaps secret to him and known only to a few insiders) and much else besides equal or greater importance.
Assumptions of Technical Analysis
The following are the assumptions of technical analysis:
1) Market discounts everything
2) The market always follows a pattern.
3) Post prices help in predicting future prices.
4) Price movements are supported by trade value.
5) Market price is determined by the forces of demand and supply.
Factors Considered in Technical Analysis
The various factors considered in technical analysis are given under
1) Volume: The intensity of price changes is reflected in the volume of transactions that accompany the change. A price increase accompanied by a low volume implies that the change is not strong enough.
2) Time: The degree of movement in price is a function of time. The longer it takes for a reversal in trend, the greater the price change that would follow.
3) Breadth: The quality of price change is measured by studying whether a change in trend spreads across most sectors and industries or is concentrated in a few scrips. A study of the breadth of the market indicates the extent to which price changes have taken place in the market by a certain overall trend.
4) Price: Price changes reflect changes in investor attitude and demand for and supply of securities.
Criticisms of Technical Analysis
The various limitations of technical analysis pointed out by its critics are given below.
1) Frequent Changes
With market chart changes, patterns keep changing accordingly. Technical analysts change their opinions about a specific investment very often. One day, they put up a buy signal.
2) Difficult in Interpretation
Technical analysis is more complex than it is. While the charts are fascinating, interpreting them correctly takes a lot of work. They are analysing the charts long after the actual point of time is always recommended, as fundamentalists argue that charting techniques are no different from palmistry.
3) Unreliable Changes
Changes in market behaviour observed and studied by technical analysts may only sometimes be reliable owing to ignorance of intelligence or manipulative tendencies of some participants.
i)Â False information or wrong judgment may result in a trade lower than the market price if the technicians fail to wait for confirmation. They incur losses.
ii)Â With actively traded stocks, prices may result from a bottle of wits, not intrinsic worth. In the game of making money. Two knowledgeable persons may buy and sell one, hoping to make money at the expense of the other(s). In this game, many may lose if they are not cleverer and weaker.
iii)Â The market prices of shares are turned into the results of certain unhealthy practices like concerning and rigging specific claims by some stock market operators.
4) Unpredictable Changes
Technicians expect change to occur in a known and gradual fashion.
i) History does not Repeat Itself: One of the significant limitations of technical analysis is that all the data is based on the past. It is presumed that failure resembles the past. There is no assurance that history will repeat itself. Systems become more sophisticated, and people become more mature, affecting a different pattern of behaviour. Further unexpected events like a change of the government, a violent agitation or a natural calamity may produce another way of behaviour. This contingency is not taken into account when making projections.
ii) No Gradual Shifts:Â It is presumed that shifts in supply and demand occur gradually instead of instantaneously since these shifts are expected to continue as the price slowly reacts to news or other factors. The price change pattern is extrapolated to predict further price changes; however, economists assert this proposition is wrong. Their unexpected walk theory has shaken the conceptual foundation of technical analysis. They believe that security price changes are a series of random numbers which occur in reaction to the random arrival of news.
iii) Less Precise Tools:Â The most significant limitation of technical analysis is the mechanical precision it gives to the entire exercise of investment in equity shares. However, the tools are subject to error breakdown and misinterpretation.
5) False Signals can Occur
Technical analysis is a signalling device. Like a thermometer, it may give a face indication when there is no alarm, but when there is cause for alarm, the signal will almost invariably be flashed.
6) No One Indicator is Perfect
Technique analysis includes many approaches, and most sequence a good deal of subjective judgment in applications. Several tests have been conducted to obtain statistically reliable estimates of the worth of various technical trading strategies. The results have been inconclusive because of different research findings using other procedures and samples.
The main problem as it applies to indicators is that while they may be apparent in definition and theory. They often break down practice.
Each of them has been ineffective at some particular time and outweighed by several other indicators. Because of this, technicians seldom rely upon a single hand; they place upon reinforcement provided by groups of indicators.
In conclusion, technical analysts are essentially those with good carse skills, not always.
Understanding Price Fluctuations: The Intersection of Fundamental Analysis and Technical Analysis in Stock Markets
The prices of most indices and stocks often fluctuate erratically. The difference between the high and low within a year may exceed a ratio of two or more, even though the fundamentals remain relatively stable. For example, despite daily price fluctuations, factors such as company earnings, book value, loans, profit margin, taxes, charges, depreciation, etc., may not change from one annual report to another. Thus, while fundamentals influence the price horizon of a company’s shares, they do not precisely determine the price at a specific time.
Technical analysis incorporates techniques to identify when an equity is overbought or oversold, allowing analysts to decide on selling and buying stocks at reasonable levels. According to a firm providing technical analysis services, technical analysts believe that price movements persist for some time regardless of their cause and form discernible patterns. Analysts aim to predict whether prices will move higher or lower and by how much by critically studying these patterns of cost and volume of trading. Technicians argue that the forces of supply and demand, influenced by both logical and emotional factors, manifest in price and volume movements. Carefully examining these patterns can reliably predict future stock prices, with this process requiring less time and data analysis than fundamental analysis, facilitating timely decision making.
Timing is crucial in trading, and investment analysts employing fundamental analysis recommend investing in fundamentally strong companies with high reserves, large profits, low debt, and high dividends. However, technical analysis can complement fundamental analysis by providing insights into the right time to buy and sell shares, helping investors avoid potential pitfalls. Many investors use technical analysis to supplement fundamental analysis to enhance their decision-making process.
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Reference:-
- https://egyankosh.ac.in/bitstream/123456789/6346/1/Unit-8.pdf