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- Fundamental analysis involves measuring a security’s intrinsic value and comparing it with the its market price to determine whether it is undervalued or overvalued at present.
- Technical analysis evaluates and identifies securities through statistics.
- You can consider utilizing a combination of both investment methods as it can bring about many benefits compared to relying on only one strategy.
Investing is an opportunity for you to work your surplus cash harder for you so as to grow your wealth and reap the rewards in the future. It is an avenue to achieve your financial goals – including funding your children’s education and building a nest egg for your golden years. More importantly, the sooner you start investing, the higher the possibility of attaining those goals.
Generally, there are 2 main types of investment methods that investors adopt to analyze benefits and risks associated with the stock market, namely fundamental analysis and technical analysis.
Fundamental analysis is an investing strategy that involves the measuring of a security’s intrinsic value or its true value. Companies are valued as though they were unlisted, without considering its market price. This is achieved through a careful examination of all related economic and financial factors which range from microeconomic indicators such as balance sheet and effectiveness of a company’s management, to macroeconomic factors such as the state of the economy, industry conditions and changes in consumer behavior.
The intrinsic value found is used to compare with the security’s current market price to determine whether the stock is undervalued or overvalued. If the stock is undervalued, you may want to buy the stock as it has a higher probability of rising in value in the future. On the other hand, if the stock is overvalued, the investor may want to sell the stock as it has a higher probability of falling in price in the long run.
Advantages of using fundamental analysis
Fundamental analysis is beneficial for long-term investments as it helps to identify companies that have the best performances amongst its peers in the same industry. A good fundamental analysis helps to identify companies which are of good value such as having valuable assets, a strong balance sheet, stable earnings and so on. It also gives an indication on the company’s and industry’s future growth prospects.
Furthermore, since people have spent much time on the research of companies, the risk of loss is far lower than the risk associated with technical trading.
Disadvantages of using fundamental analysis
However, there are some drawbacks to fundamental analysis. Although fundamental analysis provides detailed insights, a lot of time is required to conduct research to study the fundamentals of firms.
Moreover, short-term price fluctuations cannot be forecasted by studying fundamentals, hence fundamental analysis gives limited information to what might happen in the near future.
In contrast, technical analysis is an investing strategy that evaluates and identifies securities through statistics. Technical analysis is done by gathering and analyzing statistical data on market activity including returns, stock prices, and volume of trades.
Unlike fundamental analysis, technical analysis aims to predict future price movements by examining historical data, mainly price and volume. Investors that adopt technical analysis as an approach typically believes that future performance of securities can be discovered by reviewing patterns based on historical results. As such, technical analysts use chart patterns and trends, support and resistance levels, and price and volume behavior to identify trading opportunities with positive expectancy. They typically do not consider the underlying business, or the economics that affect the value of a company.
Some basic chart elements that are important to technical analysis include:
Stock price - Cost to buy one share in a company
Stock volume - Number of shares traded
Moving average lines - Tracks the share price movement over a fixed period. The direction of the moving average gives a general guideline of whether the share price is in an uptrend or downtrend.
Relative Strength Line - Compares a stock's price performance to that of an index like S&P 500. If the line is sharply rising, it indicates that the stock is outperforming the market. On the other hand, a line that is trending down shows that the stock is underperforming the market.
Advantages of using Technical analysis
Technical analysis helps in predicting the trend of the market. Investors can detect the effects of market sentiments, market psychology or supply and demand with the help of chart analysis. This also allows you to promptly review whether a stock price is in a reasonable trading range or fits the current market trend.
Moreover, technical analysis can be used to improve timing the market effectively and facilitates investors to adopt trade strategies appropriate to market conditions.
Disadvantages of using Technical analysis
There are of course, disadvantages to technical analysis. In some instances, technical analysis can give ambiguous results where two separate approaches provide contradicting outcomes on whether to buy or sell securities.
Apart from that, explosive trends and highly volatile securities would also render technical analysis ineffective in accurately predicting future trends.
Combining both investing strategies
While some investors use one of the 2 investing strategies, using a combination of both investment methods can bring about many benefits. We highlight 3 of them:
- After selecting a portfolio of stocks that are undervalued through fundamental analysis, you can use technical analysis to observe current market trends and find out if the market coincides with your valuation. You can also take advantage of technical analysis methods to determine whether you should buy a stock and when you should do so.
- In the case where fundamental analysis uncovers that the security is trading close to its intrinsic value, you can adopt technical analysis to ensure that you trade effectively within the reasonable price range to earn profits.
- There are times where overvalued securities continue trading at higher prices for a prolonged period. You may miss out on additional profits if you simply sell securities that are overvalued based on fundamental analysis. In such scenarios, you can use technical analysis and continue holding to the stock until momentum fades.
Minimizing investment risk
If you are more risk-averse or have no time to analyze the market and stocks, consider investing in Mutual Funds which are managed by expert fund managers. Consider investing via a Systematic Investment Plan (SIP) which adopts the rupee-cost averaging approach where you invest a fixed amount at regular intervals over a sustained period. This strategy will result in you lowering the average investment cost as you will be buying more units when prices are low and fewer when prices are high. At the same time, you avoid the potential pitfalls of timing the market.
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