Tuesday, May 07, 2013

Technical vs. Fundamental Analysis – Which is Better?

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Technical and fundamental analysis are the two main types of analysis in the investing world. Technical analysis is mainly concerned with price movement of a security using charts and technical studies to predict its future price movements. On the other hand, fundamental analysis looks at economic factors, which are commonly referred to as the “fundamentals,” hence the term fundamental analysis.

Fundamental analysis looks at the financial data of the company behind the stock to determine whether the company’s business will result in a higher or lower stock price. Fundamental analysis looks at revenues, profits and losses and business trends, as well as seeking growth factors that will affect the stock price. Fundamental analysis may also review more macroeconomic factors such as a company’s business sector and the overall economy in relation to a company’s lines of business. Fundamental analysis is geared toward understanding the company behind the stock. Some of the specific factors we focus on when doing fundamental analysis are:

1: Macro economic factors such as Supply and Demand and other economy new and specific industry factors.

2: Micro or company specific data including such things as Price/Earnings ratios, Price/Sales ratios, Price/book value rations, etc. Profitability: looking at gross sales, gross profit margin, operating margins, earning per share, and net profit margin. Also, factors like growth rates, Potential revenue growth, financial strength, return on investments and return on assets. Sometimes these many company specific factors are complicated and difficult to understand.

Now on the other hand, technical analysis of stocks primarily ignores the company specific issues behind a stock. Technical analysis looks at price action and volume using charts patterns and technical indicators. The theory behind technical analysis is all information about a stock is built into or factored into the share price and analyzing the price movements will predict where a stock price might go. Traders using technical analysis rely on price charts, which include analytical indicators to help traders recognize price trends or reversals and profit from these expected outcomes.

Technical analysis is appealing and has become more so in recent years, due the fact that trading systems can be developed with a specific set of rules to trigger buy and sell orders. There is also a wide range of indicators for a trader to choose from, allowing the trader to set up a trading system to fit his or her trading style. The negatives of technical analysis are using historical data to predict the future – which doesn’t always work or don’t always predict the future price action perfectly, also the different signals the different technical tools can generate make some systems confusing. Fundamental analysis is more dependent on a trader’s judgment concerning a company’s financial data. A trader using fundamental analysis can understand everything correctly about a company and stock and still see the stock go in the opposite direction because of some additional or external factor not taken into account. Fundamental analysis is sometimes favored for longer time investing, while technical analysis is often considered the better style for shorter-term trading.

For short-term trading, I definitely prefer a short-term trading plan based on price action charts using simple technical indicators while also maintaining an awareness of the fundamental factors, especially broad economic factors which may affect a specific stock or industry that I might be invested in.

By Profits Run