Differentiating Fundamental and Technical Analysis
We all know that there are two kinds of people participating in the stock market: investors and traders. Investors are those people who follow the “buy and hold” principle and remain in the market for the long haul. On the other hand, traders are those people who adopt the principle of “buy and sell” and tend to remain in the market for the short term; in fact for as short a period as a single day.
Now both these participants use two different types of methodologies for selecting the stocks. The investors use fundamental analysis while the traders use technical analysis. Here let us take a brief overview at both these methodologies.
Fundamental analysis is analyzing the company on the basis of its fundamentals. It includes details like nature of the business, company’s position in its sector of operation, its finances, management, future growth prospects etc. It also takes into account external factors like government policies, economy, inflation, taxation etc. On the other hand, technical analysis takes into the consideration the price fluctuation of the stock and uses this information to forecast the subsequent price fluctuations.
In technical analysis, the focus is mostly on charts, which show the price fluctuations of the security. The traders don’t trouble themselves with company fundamentals, as they think the stock price has factored in the fundamentals. In fundamental analysis, the focus is on the company’s financial statements. These include the sash flow statement, balance sheet and profit & loss statement. All these give the analyst the idea about the intrinsic value of the company. If the stock price is lesser than this value, it is a good buy decision and if it is over the value, it makes sense to sell it.
Another differentiating factor between both the kinds of analyses is the time horizon. In technical analysis, the time horizon is very short, at times even as short as minutes. But in case of fundamental analysis, the time horizon is very long. This is because investment in stocks is a very long term activity, while trading is a short term activity.
Also the figures required for fundamental analysis are available only for long periods, as companies tend to release their financial data over a period of 6 months or a year. Besides fundamental analysis deals with the changes in the company that will impact it over a period of many years. E.g. if a company launches a new product, it will have to spend heavily on the marketing campaigns, advertising, etc, before it can show any positive results. Investors should have the patience to wait out these changes. But traders are not affected by all this. They are just concerned with the price movements and not whether the company is in profit or in loss.
It is impossible to mix both these techniques. You can either be a trader or an investor. So only one of the techniques is available to you. Which one you will use will be decided whether you are a trader or an investor.
By: Ajeet Khurana
