Technical Analysis vs. Fundamental Analysis
Fundamental analysis attempts to measure stocks and other assets based on their intrinsic values. Technical analysis, on the other hand, doesn’t care about the underlying values. Instead, past pricing action is used, along with a few other metrics, like trading volume.
That’s technical analysis vs. fundamental analysis in a nutshell. Although these are two major schools of thought. And understanding both can be useful for investors.
That’s why I’ve broken down each type of analysis in-depth. Here at Investment U, we provide free investor education, as well as expert tips and tricks. Whether you’re new or already an experienced investor, there’s something for everyone. So let’s dive in, and below the breakdown, you’ll find more free resources.
What Is Technical Analysis?
Technical analysis uses patterns and charts to determine when to buy and sell assets. To do this, traders look at past trends to predict how prices will move in the future. And this approach is relatively new…
Early signs of technical analysis appeared in Dutch financial markets in the 17th century. We also have records of technical candlestick patterns from Asia in the 18th century. But since then, technical analysis has jumped by leaps and bounds.
Recent advances in computing have allowed for more advanced data collection, charting and trend finding. There are now thousands of technical trading techniques. Many brokerages even provide built-in technical tools. Here are some popular techniques…
- Trading volume changes (liquidity)
- Relative strength (RSI)
- Moving average convergence divergence (MACD)
- Average directional index (ADX).
Compared with fundamental analysis, technical trading usually involves much shorter holding periods. Technical traders can enter and exit a position within minutes. This is one key difference when compared with the fundamental side.
For a further breakdown, check out this beginner’s guide to technical analysis.
What Is Fundamental Analysis?
Fundamental analysis seeks to find the underlying value of a business. And this investing approach is often associated with Warren Buffett and his mentor, Benjamin Graham.
To do this, analysts look at a company’s current financial position, as well as future prospects. Ultimately, a company’s earnings and other cash flows will determine what the business should be worth.
When value investing, the goal is to find stocks with an intrinsic value higher than their current share price.
In the short term, intrinsic value and market price can differ by a wide margin. But over the long run, price and underlying value tend to converge. That’s why fundamental analysis is usually paired with long-term investing.
There are also many useful metrics to help determine underlying value. One of the more popular ones is the price-to-earnings (P/E) ratio. But that just scratches the surface. One of my favorites is the enterprise value to earnings before interest, taxes, depreciation and amortization (EV/EBITDA) ratio. That’s a mouthful, but it gives a better sense of a company’s actual cash flows.
Here are some other useful fundamental analysis metrics…
- Price-to-sales (P/S)
- Debt-to-equity (D/E)
- Price-to-book (P/B)
- Return on equity (ROE).
Similar to technical analysis, there are thousands of techniques. Some work better than others, and they can also be industry specific. For example, the real estate industry tends to use more leverage, and that can result in higher debt ratios.
Technical vs. Fundamental Analysis Key Differences
Fundamental analysis is focused on underlying value, and technical analysis is focused on trends. And you’ve maybe heard that the trend is your friend. That’s true. It can be useful for finding better times to enter and exit positions. But over the long run, fundamental analysis is a good way to go.
Now that you know the ins and outs of technical analysis vs. fundamental analysis, what’s the next step? You can use them both to improve your returns. And to see how your portfolio can grow, check out this free investment return calculator. Will it take you five, 10 or 20 years to reach financial freedom?
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