Some people think that investing in the stock market is like gambling, but experienced investors who do their homework usually make a profit through market analysis. However, even experienced investors will debate which type of analysis—fundamental analysis or technical analysis—provides higher returns. Will they lead to the same choice? What does it mean when these two methods contradict each other?
The difference between fundamental analysis and technical analysis
In short, fundamental analysis aims to determine intrinsic value by looking at business strength, financial analysis, and operating environment including macroeconomic events. Technical analysis analyzes the past market performance by viewing the chart activity of price changes, volume, moving averages and various results of statistical data. Fundamental analysis assumes that the efficient market theory is established in the long-term and tries to take advantage of inefficiencies in the short-term.
Technical analysis assumes that the fundamentals are already priced, and try to find patterns that lead to a high probability of the outcome. Technical analysis also captures the psychological aspects of the market by reviewing past patterns. Fundamental analysis does not consider investor psychology, but believes that fundamentals will dominate in the long term, so short-term psychological fluctuations will correct themselves. Generally speaking, there are differences in the types of investors who tend to analyze specific types. Technicians are generally more inclined to short-term transactions in nature, which contrasts sharply with the long-term views that fundamentalists usually take.
The relationship between technical and fundamentals
Fundamentals drive technical or vice versa? In the short term, strong fundamentals do not always indicate strong technical patterns, and vice versa. Normally, when the fundamentals are at a turning point, the technicals will continue to follow a strong-weak pattern, which may cause them to get out of sync. In addition, when the stock receives a positive or negative impact, the technical picture may not be synchronized with the fundamentals.
Unless there is an unforeseen shock, stocks tend to follow the technical side in the short term. For example, sometimes stocks start to change before a new major disclosure is made public. Due to non-compliance with Rule D, no insider trading or improper disclosure, technical analysts say that you can respond to stocks in real time without having to wait for the next report date or news disclosure, because the chart has already explained the market sentiment, so please follow the chart will bring more High profits.
Technical analysts believe that even if there is no disclosure, stocks will fluctuate because suppliers, competitors, and employees, as well as all their family members and friends, are investing in the company and can understand the company’s operations without internal information. These buying and selling activities define stock charts and patterns and reflect real-time stock behavior.
Sometimes, when the market is surprised by the new disclosures, the chart may fail, at least in the initial stage, when the accident causes the market to overreact, reviewing fundamentals may use short-term mispricing to gain long-term profits. The news is temporary and may have a positive or negative impact on the fundamentals of the stock, so it may be more cautious to follow the fundamentals after the shock. Later, the use of technical analysis may provide an opportunity to take advantage of corrections or rebounds after the news is absorbed. Therefore, even if the two are out of sync in the short term, in the long run, the technical and fundamental aspects should be synchronized. That’s because in the long run, the fundamentals should win and push the technical side.
The investment time frame usually determines when the technical or fundamental analysis makes sense. Since technical and fundamentals often seem to be out of sync at inflection points, the investment time frame usually comes into play. It is generally believed that short-term investors follow the technical side, while long-term investors are willing to bear the daily “flash” and follow the fundamentals. For example, if you think that genetically modified seeds are the future of agriculture, you might invest in a related company—such as Monsanto—and be willing to stick to it, although the stock may experience any short-term noise.
Critics believe that fundamental analysis can lead to improper valuations and therefore improper investment decisions, because most of the information is retrospective. Financial statement analysis, 10Q and 10K comments, and macroeconomic environment focus on what has happened. Investors use this information to simulate expected future results. The problem is that predictions are very subjective, rely on the expectations and disclosures of the company’s management team, and in some respects may be self-fulfilling predictions. The term “garbage in, garbage out” is often used in conjunction with modeling related to the determination of the intrinsic value of fundamental analysis.
On the other hand, critics of technical analysis believe that chart patterns are effective until they fail, and that pattern failure may not always be predicted by following past patterns, especially in the event of unforeseen shocks. One way to reduce the shortcomings of these two methods is to use them together to capture the best aspects of both. Fundamental analysis should be used to determine which stocks or industries are most likely to perform well based on the strong macroeconomic environment and the operating conditions of the company or specific industry. Then you can use technical analysis to decide when to buy or sell by giving entry and exit points based on moving averages, volume, and price trends.
By using these two strategies at the same time, you can establish a position in a company with strong fundamentals while avoiding buying stocks that have risen and are overvalued. Technical analysis can help you avoid buying high and selling low, which often happens when psychology begins to dominate trading.
Fundamental and technical analysis do not have to contradict each other or be restricted to a certain range. Sometimes, there may be only one indicator to provide information for technicians and fundamentalists. For example, price volatility is an important technical indicator of risk-the greater the volatility, the greater the risk. This may be a leading indicator that fundamentals are changing. Therefore, both parties will agree on the buy/sell decision.
Sometimes investors like to classify themselves as an investment style, but being open to portfolio styles may provide the best opportunity to maximize profits. Technology and fundamental analysis do not have to be used separately, but can be used together to draw a complete investment picture. Fundamentals can be used to determine suitable goals, while technical aspects can be used to make trading decisions. In short, these methods can produce a convergence of information and provide better investment opportunities than either method alone.