In the world of finance, two terms are often used – Fundamental Analysis and Technical Analysis. These terms are used in making investment decisions and tons of material has been published on both the ways.In this article,we will try and understand what is the difference between these strategies and which one is better.
Fundamental Analysis involves analyzing the intrinsic value of the stock. It takes into account the overall economy, industry condition, strength of the business and various other things.
Technical analysis on the another hand does nothing what fundamental analysis does. It does not understand whether the company is good or bad, whether the business environment is good or bad; it simply takes into account the “TREND” or “DIRECTION”. It simply tries to analyse the way in which the price movement can take place in future. It studies the past performance in order to determine the price movement in the future.
What differentiates them?
Fundamental analysis takes a long term approach to analyse the data. It could be from 1 year to many years. On the other hand, technical analysis takes a comparatively short term approach – from few minutes to few days to few weeks. Fundamental analyst looks at data of over a number of years to come to his conclusion, but technical analyst takes into account short term data to predict future prices.
In technical analysis, it is assumed that markets at any given point of time reflects the true price of the stock like economic situation of the country, industry position, etc. Basically, it assumes all the fundamental factors that affects price of the share are already priced in or factored in the price.
Fundamental Analysis assumes that price of the company reflected in the market is either over-valued or under-valued.
Charts v/s Financial Statements
Fundamental analyst looks at financial statements like Profit and Loss Account, Balance Sheet, Cash Flow statements and over all economic growth. The objective is to find those companies whose share prices are lower than the intrinsic value of the company.
Technical analyst on the other hand read charts. There are various kinds of charts like daily charts, weekly charts, 200 day chart etc. They believe that all the factors which affects the company is reflected in it’s price and hence there is no need to do the fundamental analysis.
Investment vs. Trading
For those who wish to invest for long term financial goals or long term wealth creation must believe in fundamental analysis. Those who wish to make quick return should consider the technical analysis. Fundamental analysis is helpful for long term wealth creation whereas technical analysis is likely to create some income. For the benefit of readers, wealth is something which helps you to change your life style and income creation helps you to maintain your life style.
Which is a better?
Bhagwan Shree Krishna in Bhagavad Gita said to Arjun – ask yourself “WHO AM I” and you will know; what you have to do. The same logic applies here as well. There is no one strategy which is the best. There are traders and there are investors. Take for example gold; there are people who buy it and sell it and they are very much interested in knowing price of it on daily basis. They are interested in knowing the factors which affect the price of gold on day-to-day basis. At times, they incur loss as well in short term; but then that is part of the entire strategy.
On the other hand we have investors in gold. They buy it and forget it. The buying of gold is often for purpose like marriage or personal use etc. Hence, they do not like to see the prices of gold on daily basis.
So is the case with investment in shares or equity funds. There are traders and there are investors. But in case of shares, the problem is the awareness of identity. Most of the persons do not know the answer of “WHO AM I”. When markets are good, people become investors and start believing in long term theories. When markets are bad, they start behaving like traders and keep looking at markets on day-to-day basis.
People who are investors have earned more than people who trade. We say businessmen are wealthy. So do they become wealthy by entering in and exiting out of business or they simply stay invested in the business. Look at Birla’s, Tata’s, or for that matter any businessmen you could think of. Are they rich because they trade in their stocks or they are rich because they remained invested in their stocks.