When approaching investment in the stock market, two standard methodologies are used to predict the outcome of a stock: Fundamental Analysis and Technical Analysis. This article aims to explain both the methods in detail so you can understand the difference between them.
Fundamental Analysis
In this type of analysis, the future potential of a stock is measured by considering macro factors such as the country’s GDP growth, interest rate, inflation rate, etc. With this, the micro factors such as the company’s profitability, liabilities, cash holding, etc., are also considered. This analysis aims to build value for the stock that would factor in all of these underlying factors. This is regarded as a long-term investment approach as the approach doesn’t look at short-term pricing and trading swings.
How to do Fundamental Analysis?
There are six steps that one should follow to analyze the fundamentals of company stock in an Indian market, and they are as follows:
Using Financial Ratios
On the Indian Stock Exchange, there are over 5,500 stocks listed. It might take years to read the financials of all these companies. Financial ratios such as PE ratio, P/B ratio, Current ratio, etc., are helpful for the initial screening of the stocks.
Understanding the Company
It is essential to understand the company that you invest in. This is a crucial step because knowing the company’s performance and its future goal helps you decide whether you should hold or sell the stock.
Studying the Financial Reports of the Company
Once you have understood the company, you should move on to check the company’s financials, such as the profit loss statement, cash flow statement and Balance Sheet.
Check the Debt
One of the critical factors to check before investing in a stock is the company’s debt. A company cannot perform and reward its shareholders if it is in massive debt. As a result, it is best to avoid companies in debt.
Competitors
Determine what this company is doing that its competitors aren’t. Studying the company’s peers before investing in it is an excellent move. Further, it would help if you were answerable for why you are investing in this company but not its competitors.
Analyzing the Future Prospects
Always invest in a company with excellent prospects. Select only those companies to invest in whose products or services will still be used 20 years from now.
Moreover, there is no point in investing in a CD or pen-drive-making company with no long-term (say 20 years) prospects. If you plan to invest for the long term, the long life of the company’s product is a must criterion to check.
Technical Analysis
Technical analysis is an investment methodology that looks at historical market data such as share price movement, option interest, volume, etc., for predicting the future price direction of a stock. This analysis aims to capitalize on pricing opportunities and trends that can be identified in the market activity around each share. As the methodology is purely based on historical market activity, this is considered to be a backwards-looking methodology.
How to Conduct Technical Analysis?
In this section, we discuss how to conduct technical analysis. One should remember that technical analysis can vary from simple to complex. The first thing to do while conducting a functional analysis is to pick a stock to examine. Suppose we choose Apple stock, then we begin by pulling out the chart of Apple’s price movements. Then, set a time frame — either five days, one month or longer (like three months or one year). Some questions to ask while analyzing the chart are as follows:
- Is the stock trending toward the resistance line, indicating a possible selling or shorting opportunity?
- Is the stock trending toward the support line, signalling a potential buying opportunity?
- What is the stock’s short-term trend — upward, downward or sideways?
- How has the stock’s price performed over the long term? Is Apple experiencing an overall upward trend?
While there is undoubtedly an exhaustive list of questions and aspects to consider when conducting technical analysis, getting yourself acquainted with the many tools and charts involved can be beneficial to become a more educated investor.
Fundamental Analysis vs Technical Analysis
Now that we have acquainted ourselves with financial analysis and technical analysis, let us look at the differences between them:
| Fundamental Analysis | Technical Analysis |
| Stock value is calculated using economic factors known as fundamentals | The future price movements are predicted using the price movement of security |
| Data is gathered from the financial statement | Data is gathered from charts |
| Stocks are bought when the price falls below intrinsic value | Stocks are bought when traders believe that they can sell them for a higher value |
| It is a short-term approach | It is a long-term approach |
| The function of fundamental analysis is an investment | The function of technical analysis is trading |
| A few of the concepts used in Fundamental Analysis are Return on Equity and Return on Assets | A few of the concepts used in technical analysis are Dow, theory and Price Data |
| The vision of this method is to look backwards as well as forward | The vision of this method is to look back only |
Which is the Best?
Successful investors use fundamental analysis methods to identify stocks to buy or sell and technical analysis to decide when. It is difficult to say which of these methodologies is the best because fundamental analysis works best for long-term investing. In contrast, technical analysis is useful for short-term trading and investment. Since both methods are helpful, most brokerages employ both these analyses.
Recent Comments