Anyone can trade in the stock market, but that doesn’t mean they know what they are doing. If you are lucky, you can make a good deal of money but you are just as likely to lose it all. You probably hear stories about people who have made fortunes investing and trading in the market. Everyone has a story to tell – from legends like Warren Buffet to your dentist who made a fortune on some tech stocks. So how do you filter out the “luck” component from the theory of investing? Well, the truth is there is no 100% foolproof way to make money in the securities market. However, there is a method to all the madness and decades of investing experience has led to the creation of the science behind the financial analyst.
So What Does A Financial Analyst do?
In financial markets, an analyst is someone who uses various data, tools, methods, insights and his own experience to predict the price of an asset or security. There are various techniques that allow him to do this, but broadly speaking there are two main categories of financial analysis – fundamental and technical. Both technical and fundamental analysis use very different techniques to achieve the same goal – predict the future price of a security.
Are you A Fundamental analyst or a technical analyst?
Now that you broadly know what an analyst does, it’s time to figure out where you fit. Fundamental and technical analysts, although they are essentially trying to achieve the same things, don’t really get along that well. Why is that, you ask? Because they believe that their own method of finding a good trade is the right one and everything else is either inefficient or worse – a sham!
So before we get mired in the eternal struggle between the fundamental and technical schools of thought, let’s quickly see where you stand.
Philosophy: Fundamental investors look at the bigger picture – the state of the economy, how well a company is run, what is the demand for a company’s product, what are the technological innovations or challenges, and so on. Using this information, they build models to predict the price of a stock or any other security. Technical investors, on the other hand, only look at past data of a stock to predict a future. For example, they may look at trading volume or price trends over a week, other patterns in the data and so on to predict where the stock price is headed.
So which one do you feel is more important? How the company is run or the price trend over the last three days? You should remember that in case a stock is plummeting, not many are going to care about the fundamentals, they are going to follow the herd and sell before they are wiped out!
Information sources: Fundamental analysts will usually look at a company’s balance sheet, cash flow statement, profit and loss statement, other strengths and weaknesses, and market outlook etc. for information. Technical analyst will mostly look at historic trading data only for a stock and do not really care for a company’s financials.
Unfortunately, both methods require staring at financial figures on a spreadsheet. Luckily, there are tools that convert all this information into nice looking graphs and charts! Essentially, the choice comes down to this – will you buy something based on what you think it’s worth in the long term or based on the price it has been selling for in the last one week?
Investment Horizon: The data sources and methodology that technical analysts utilize gives them the ability to try and predict changes in the next few minutes, hours, days, weeks or longer. They thus have the flexibility to use their techniques to suit their requirement in terms of investment horizon. If you are a day trader, you have to use technical analysis. Fundamental analysts will normally look at a time horizon of multiple weeks or even years. They try to figure out the appropriate price for a security but it may be years before the stock actually reaches that value. These are usually long term investments based on what analysts believe to be a solid business foundation. Think more Warren Buffet here.
This is an easy one. Do you want to trade quickly, churn a lot of money and get in and out of companies in a matter of minutes, days or at most a few weeks? Or do you want to latch on to a golden goose and ride the roller coaster for the next few years- learning everything there is to know about a company?
Feeling the market. Technical analysts read the pulse of the market. They look at the charts and can sometimes predict market sentiment based on these charts. Consequently, they are closer to the actual stock markets than fundamental analysts who care more about the company’s core strengths rather than the stock market. If the stock market or a particular security is stressed due to any reason, fundamental analysts may not feel the need to respond as they are focused more on a companies core competencies.
So do you like to shoot from the hip, based on a fair amount of instinct or do you do what the numbers tell you to do?
So Who Wins?
Well, the answer is it depends. If one method was clearly superior to the other, then there would only be one method left! Earlier, most analysts on Wall Street were proponents of the fundamental school of thought. Many did not even believe that technical analysis even works. However, these days there is more acceptance of the technical aspects of trading.
The truth is that there is more differentiation between the quality of an analyst rather than their analysis philosophies. A good fundamental analyst might beat an average technical analyst in terms of accuracy and vice versa. Sometimes good fundamentals do not lead to success, and sometimes historical stock price patterns do not repeat themselves. The decision to choose the appropriate method of analysis is actually just as important as doing the analysis correctly.
Choosing which Method Works for You
While choosing which school of thought you should follow, consider the following:
- If you need short term gains go for technical analysis. For a long term investments (months or years), go for fundamental analysis. Basically technical analysis for a day-trader and fundamental for a long-term investor.
- If you are good at seeing patterns in things and quickly making decisions, then go for technical analysis.
- If you want to look at the bigger picture and have a good understanding of how interest rates, trade data, or growth forecasts might affect a company then go for fundamental.
- You might even want to mix things up. Use fundamental analysis to identify a target company and technical analysis to decide when to jump in on the trade.
If you’re still unclear about the difference between fundamental and technical analysis, we made a little video to help explain the concept further!
If you want to learn more about security analysis then feel free to check out our courses on fundamental and technical analysis. Remember, whichever method you use, success depends only on how good you are as an analyst!