Technical vs fundamental analysis. What’s the difference and which should you choose?
Even if you’re completely new to investing, you might have stumbled upon these two different types of analysis. But what’s the difference between them?
Well, here it is. Technical analysis is all about predicting short-term price changes. In contrast, fundamental analysis is supposed to predict a long-term change in a security’s value. The first does it after analyzing securities and market movement. The latter by analyzing business financials.
In this article, I will go into more depth defining the two investment approaches and I will also help you decide which is for you.
Sounds good?
Let’s dive in!
What’s Technical Analysis
Technical analysis allows traders to identify trade opportunities by predicting price movements. In other words, technical analysts will examine technical indicators before they decide whether to enter or exit a trade and when.
More specifically, when you use technical analysis, you’re mostly concerned with past price movements. The goal is to spot price trends. Besides price movement, you will also want to examine trading volume at various price points. This way, you can predict a change in the direction of the price, that be up or down.
Technical analysis is based on the assumption that all key financial data are reflected in the price. That presupposes that there’s just no way that you can find businesses that are undervalued.
So, technical analysts feel like it’s better to focus on the short-term price fluctuations that may be based on historical price patterns. The job as a technical analyst, therefore, is to identify such patterns.
For an introduction to technical analysis, check out this post.
What’s Fundamental Analysis?
Fundamental analysis is a type of security analysis that aims to measure a business’s intrinsic value. It’s usually accomplished by analyzing fundamental data. These data can range from a business’s financials to the condition of the market and industry.
But most of the time, the job of a fundamental analyst focuses solely on a business’s condition and the economics of the company. In fact, everything from management quality to assets, debt, earnings, and expenses can provide a clue or two about a company’s intrinsic value.
Fundamental analysts hold the opinion that security prices don’t always reflect the value of the underlying business. They believe that the market can sometimes price some securities way lower or higher than their value.
This actually happens all the time. Not always to the degree that can guarantee easy and great profits, of course. But people, in general, have the tendency to not trade based on fundamentals, but emotions.
This explains why fundamental analysts are so interested in financials and management quality. Even if the market gives a stock a certain price, the business’s quality and the reported financial data may indicate otherwise.
For a beginner’s friendly guide to fundamental analysis, check out this post.
Which Type of Analysis Is for you?
So, what kind of analysis should you use before you start investing?
Well, it depends. You need to think about your intentions first.
Are you thinking about allocating some money to trading that you can afford to lose? Then either will do; though most traders want to be constantly active so technical analysis is probably for them.
In contrast, if you are serious about investing and you want to use your retirement fund, you will need to learn fundamental analysis. This ensures that you don’t take very high risks and it can help you grow your money in the long-term.
Whatever you choose, however, keep in mind that you will still need to spend some time learning. Both fundamental and technical analysis can take time to master.
Of course, with technical analysis, you can afford many and frequent mistakes. But this doesn’t apply to fundamentals. If you are about investing money for retirement, you need to take it slow and be very conservative.
Conclusion
All in all, both fundamental and technical analysis can help you feel like you invest or trade based on a principle. The difference is that the first concerns itself with price behavior and the second with underlying economics.
To recap, technical analysis uses price charts to identify trade opportunities. But fundamental analysis mainly uses financial ratios to identify the intrinsic value of a security.
If you’re torn between the two, just ask yourself: what do I want and what is my risk tolerance? If you want to trade for fun, then use technicals. But if you want to invest for retirement, use fundamentals.
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Also, please ask me anything you want down in the comments and I’ll get back to you as soon as I can.
Take care for now…
Disclaimer: This information should not be viewed as financial advice. You should consult a financial advisor or do your own due diligence before you invest. The owner of this website and author of this article are not to be held liable for any undesired result by anyone who uses this information that is provided here in any way.
