Technical analysis and fundamental analysis are two different methods used by traders to evaluate investments in financial markets. While both approaches seek to predict future price movements, they use different tools and techniques to achieve this goal. In this article, we will take a closer look at both approaches to better understand when which is used and how they work.
Fundamental Analysis
Fundamental analysis focuses on the financial health and performance of a company, such as its revenue, earnings, assets, and liabilities. Traders who use this approach examine financial statements, news articles, economic reports, and other publicly available data to assess a company’s value and potential for growth.
One of the key assumptions of fundamental analysis is that the stock market is inefficient and that share prices do not always reflect a company’s true value. Therefore, by analysing a company’s financial statements, traders can identify shares that are undervalued or overvalued and make investment decisions accordingly.
For example, if a company has a strong track record of revenue growth and high earnings per share, it may be seen as undervalued if its share price is lower than its peers in the same industry. Alternatively, if a company’s debt levels are too high or its revenue growth has slowed down, it may be seen as overvalued if its share price is higher than its peers.
Fundamental analysis can be used for both long-term and short-term trading strategies, depending on the trader’s goals and risk tolerance. Some traders may hold onto a share for years, while others may buy and sell shares in a matter of days or hours.
Technical Analysis
Technical analysis, on the other hand, focuses on the price movements of a share and the patterns that emerge from those movements. Traders who use this approach use charts, graphs, and other visual aids to identify trends, support and resistance levels, and other indicators that can predict future price movements.
One of the key assumptions of technical analysis is that share prices move in trends and that these trends can be identified and analysed to make profitable trades. Technical analysts also believe that market psychology and sentiment play a role in determining price movements, and they use various indicators to gauge these factors.
For example, if a share’s price has been steadily increasing over time, a technical analyst may identify an upward trend and use this information to make a buy decision. Alternatively, if a share’s price has been fluctuating within a certain range, a technical analyst may identify support and resistance levels and use this information to make a sell decision.
Technical analysis is generally used for short-term trading strategies, such as day trading or swing trading, where traders aim to profit from small price movements. However, some traders may also use technical analysis to inform long-term investment decisions.
One of the key differences between technical and fundamental analysis is the type of data used. Fundamental analysis relies on financial data and other qualitative information, such as news articles and economic reports, to assess a company’s value and potential for growth. Technical analysis, on the other hand, relies on price and volume data to identify trends and patterns.
Both technical and fundamental analysis have their strengths and weaknesses, and traders may use a combination of both approaches to make informed investment decisions. For example, a trader may use fundamental analysis to identify undervalued shares and then use technical analysis to identify the best entry and exit points for a trade.
In conclusion, the choice between technical and fundamental analysis depends on a trader’s individual style, preferences, and goals. By understanding the key differences between these two approaches, traders can make more informed decisions and improve their chances of success in the financial markets. While fundamental analysis focuses on evaluating the intrinsic value of an asset based on economic, financial, and industry data, technical analysis is centred on identifying patterns and trends in price and volume data.
