Fundamental Analysis vs. Technical Analysis
It is common for traders to be faced with uncertainty during trading due to the fact that markets can be volatile and unpredictable. Nonetheless, despite this unpredictability, traders can employ trading analysis to help them to navigate this uncertainty.
While there are many types of trading analysis and strategies available, two of the most common ones among traders are fundamental analysis and technical analysis. So what exactly are fundamental and technical analyses, what’s the difference between the two, and what are the pros and cons of each type of analysis?
What Is Fundamental Analysis?
To understand how fundamental analysis works, it is necessary to know what a financial asset’s intrinsic value is. Simply put, an asset’s intrinsic or fundamental value differs from its market value in that the former looks into the asset’s worth based on analyzing price patterns. Following this logic, fundamental analysis looks into the securities’ intrinsic values by taking into account the assets’ economic health and the current market conditions. Fundamental analysis, therefore, aims to determine the price investors will be able to compare with a security's current price to determine whether it is overvalued or undervalued. In other words, by using fundamental analysis, an investor can determine whether a security is undervalued or overvalued based on its current price.
What Is Technical Analysis?
Technical analysis looks into past performance and price patterns by analyzing trading charts in order to determine how an asset might act in the future. Technical analysis also uses a security’s trading volume in the past in order to gauge how it might perform in the future. This is because technical analysts believe that past performance can have a valuable impact on future results.
Key Differences Between Fundamental and Technical Analysis
When deciding whether the technical or fundamental analysis is the best choice for you, it might be good to keep in mind the following differences between the two:
- Timing: technical analysis is usually more suitable for short-term gains and trading opportunities whereas fundamental analysis is usually more suitable for long-term goals since it focuses on an asset’s financial performance and future growth prospects (earnings, profits, revenue, etc.) rather than its past performance. This might also mean that while these types of analyses can be used by both traders and investors alike, technical analysis is more suitable for traders, whereas fundamental analysis is more suited for investors.
- Goals: traders use technical analysis to find when to enter or exit the market whereas traders use fundamental analysis to examine a financial asset’s intrinsic value.
- Tools: technical analysis uses trading charts to locate and understand price patterns and predict future patterns, while fundamental analysis uses a combination of financial data, companies’ earnings, revenue, growth prospects, reports, and more.
Despite these differences, both types of analysis have their pros and cons and can be equally valuable when it comes to understanding the market better.
Pros and Cons of Fundamental Analysis
Advantages of Fundamental Analysis
- Longevity: perhaps one of its main advantages is the fact that fundamental analysis provides a long-term outlook on the markets.
- Value: since fundamental analysis uses financial data it can help traders spot valuable market assets and trading opportunities. In addition, it gives traders a more nuanced perspective on the market.
- Alerts: fundamental analysis keeps traders informed and alerts them on any problematic prospects when it comes to their underlying asset. Therefore, traders can use it to determine when to enter or exit a position.
Disadvantages of Fundamental Analysis
- Timing: while the fact that fundamental analysis can be a good type of trading tool for long-term investors or traders, it means that data can take a long time to materialize which makes it less attractive to those seeking short-term gains.
- Biased: those who critique fundamental analysis claim that it is hard to be objective when attempting to see the intrinsic value of a financial asset.
Pros and Cons of Technical Analysis
Advantages of Technical Analysis
- Up-to-date Data: since technical analysis relies on price patterns, it is considered to be up-to-date, making it a good tool for those who seek to understand the current market trends.
- Timing: technical analysis price charts can help traders time their trades which means that through technical analysis traders can base their decisions on past patterns. This is because technical analysts believe that history can repeat itself.
Disadvantages of Technical Analysis
- Lack of accuracy: some posit that technical analysis is not precisely accurate and since past performance does not necessarily influence future results, technical analysis can sometimes be misleading.
- Lack of objectivity: despite the fact that technical analysis uses existing data from events that already took place, technical analysis is often criticized for its lack of objectivity. The reason for this is that different individuals can analyze the data in different ways.
Using Fundamental and Technical Analysis Together
For traders who aim to potentially benefit from both types of analysis, a combination of fundamental and technical analysis can be useful. This may be helpful to traders since the two types of analysis can be helpful when it comes to risk management, help you evaluate your underlying asset, and both rely on past and present data.
In conclusion, if you are interested in technical or fundamental analysis, it may be prudent to weigh the differences between the two before deciding the best fit for your goals. In addition, you may also choose to use a combination of both types of analysis in order to get the best out of each one.