Approaches to analyze stock: fundamental analysis and technical analysis

Investors and traders utilize technical analysis and fundamental analysis as primary methods to make decisions in the financial markets.

While both aim to analyze and predict market movements, they differ significantly in methodology and focus. In this post, we will examine the basic differences between technical and fundamental analysis, their strengths and weaknesses, and how they can be used for market analysis.

What is Fundamental Analysis?

Fundamental analysis aims to determine the fair value of an asset by evaluating both rational factors—such as a company's earnings, forward guidance, and macroeconomic conditions—and irrational factors like market sentiment and media coverage. By focusing on the rational aspects, fundamental traders seek to uncover what they perceive as the true value of an asset.

Traders then assess whether the asset's intrinsic value is higher or lower than its current market price, allowing them to make investment decisions based on perceived undervaluation or overvaluation. If an asset is deemed undervalued, the trader will buy it; if overvalued, they may sell it or wait for a more favorable opportunity when the asset's true value decreases.

For instance, a fundamental analyst trading shares will closely examine a company’s earnings, while a forex trader will analyze macroeconomic indicators like GDP or inflation, as well as any shifts in monetary policy. Although fundamental analysis can be applied in the short term, it is generally aligned with a long-term investment strategy.

What is Technical Analysis?

Technical analysis focuses on the historical price movements of an asset to predict its future price. Advocates of this approach believe that an asset's price chart conveys valuable insights about its future performance.

While fundamental analysis is typically concerned with long-term returns, technical analysis is geared toward optimizing short-term trades. Traders utilize technical analysis to identify potential entry and exit points based on past price trends, employing various strategies like moving averages, Fibonacci retracements, and Bollinger bands.

A common technique in technical analysis is the use of candlestick charts, where green candlesticks indicate bullish movements and red candlesticks signify bearish trends. The size of the candlestick reflects the difference between the opening and closing prices, while the "wick" shows the highest and lowest prices within the trading session.

Traders may also analyze moving averages to smooth out price volatility and identify the direction of trends. For example, a commodities trader might track the 21-day moving average of oil prices and compare it to the current price. A breach of this average could signal a bullish trend, suggesting that prices may rise further.

Key Differences Between Fundamental and Technical Analysis

Fundamental analysis focuses on evaluating an asset's intrinsic value through economic indicators, financial performance, and market conditions. It aims for long-term investment strategies by assessing factors like earnings, management, and macroeconomic trends.

In contrast, technical analysis revolves around historical price movements to predict future price actions. This approach is primarily used for short-term trading, employing tools like charts, candlestick patterns, and indicators such as moving averages to identify entry and exit points.

While fundamental analysts prioritize the underlying value of an asset, technical analysts concentrate on price trends and market sentiment. This results in a significant distinction in their investment horizons: fundamental analysis typically supports long-term growth, whereas technical analysis seeks to capitalize on short-term price fluctuations. Understanding these differences can guide investors in selecting the most suitable approach for their trading or investment strategies.

When considering shares, indices, forex (foreign exchange) and commodities for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss.

Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.