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Fundamental Analyses Vs Technical Analyses
Fundamental Analyses Vs Technical Analyses
TECHNICAL
ANALYSES OF SHARES
At a very broad level, there are two disciplines of doing the stock analysis:
Fundamental Analysis of stock
Technical Analysis of stock
Both are very different from each other and attract market participants of different financial
Within fundamental analysis, investors can choose to adopt either of the following two styles:
Top-down Approach – Starts with an analysis of broader economic levels. It then identifies key
sectors that will benefit in the current economic and business environment. This is followed by the
identification of the best companies within the sector for actual investment.
Bottom-up Approach – This approach follows a reverse path where analysts start with a company
and analyze qualitatively and quantitatively factors, before moving up to analyze broader variables
like industry and economy.
Technical Analysis of stock
Followers of technical analysis believe that the price of stock contains all the required information
and hence, there is no need to do a deeper fundamental analysis of the company’s business. This
way of analysis is based on the concept that market action discounts everything.
According to technical analysis, the trends in price and volume of shares tend to repeat over time,
as investors as a group respond in similar behavior patterns. So by looking at the price and volume
trends, traders through technical analysis try to figure out - how the stock’s prices will move in
future.
Extensive backtesting of historical price and volume data is carried out to test investment strategies
based on technical parameters.
Technical analysis is generally short-term in nature. It is usually practiced by traders and is used
on very small periods ranging from hours to even weeks. This is in stark contrast to fundamental
analysis that uses data spanning several years to arrive at conclusions.
BACKGROUND OF TECHNICAL AND FUNDAMENTAL ANLYSES:
ABSTRACT :
The unique nature of capital market instruments forces investors to depend strongly on
fundamental factors in their investment decisions. These fundamental factors relate to the overall
economy or a specific industry or a company. The performance of the securities that represent the
company can be said to depend on the performance of the company itself. However, as companies
are a part of industrial and business sector, which in turn are a part of overall economy, so even the
economic and industry factors can affect the investment decision. The selection of an investment
will start with fundamental analysis. Fundamental analysis examines the economic environment,
Fundamental analysis is the examination of the underlying forces that affect the well being of the
economy, industry groups and companies. As with most analysis, the goal is to develop a forecast of
future price movement and profit from it. At the company level, fundamental analysis may involve
examination of financial data, management, business concept and competition. At the industry level,
there might be an examination of supply and demand forces of the products. For the national
economy, fundamental analysis might focus on economic data to assess the present and future
growth of the economy. To forecast future stock prices, fundamental analysis combines economic,
industry, and company analysis to derive a stock’s fair value called intrinsic value. If fair value is not
equal to the current stock price, fundamental analysts believe that the stock is either over or under
valued. As the current market price will ultimately gravitate towards fair value, the fair value should
be estimated to decide whether to buy the security or not. By believing that prices do not accurately
reflect all available information, fundamental analysts look to capitalize on perceived price
discrepancies.
The fundamental analysis is a 3 phase analysis of a) The economy b) The industry and c) The
company
1. Long-term Trends Fundamental analysis is good for long term investments based on
long-term trends. The ability to identify and predict long-term economic,
demographic, technological or consumer trends can benefit investors and helps in
picking the right industry groups or companies.
2. Value Spotting Sound fundamental analysis will help identify companies that
represent a good value. Some of the most legendary investors think for long-term
and value. Fundamental analysis can help uncover the companies with valuable
assets, a strong balance sheet, stable earnings, and staying power.
3. Business Acumen One of the most obvious, but less tangible rewards of
fundamental analysis is the development of a thorough understanding of the
business. After such painstaking research and analysis, an investor will be familiar
with the key revenue and profit drivers behind a company. Earnings and earnings
expectations can be potent drivers of equity prices. A good understanding can help
investors
Knowing Who is Who:
Stocks move as a group. Knowing a company’s business, investors can better categorize
stocks within their relevant industry group that can make a huge difference in relative
valuations. The primary motive of buying a share is to sell it subsequently at a higher price.
In many cases, dividends are also to be expected. Thus, dividends and price changes
constitute the return from investing in shares. Consequently, an investor would be
interested to know the dividend to be paid on the share in the future as also the future price
of the share. These values can only be estimated and not predicted with certainty. These
values are primarily determined by the performance of the company which in turn is
influenced by the performance of the industry to which the company belongs and the
general economic and socio-political scenario of the country. An investor who would like to
be rational and scientific in his investment activity has to evaluate a lot of information about
the past performance and the expected future performance of companies, industries and
the economy as a whole before taking investment decision. Each share is assumed to have
an economic worth based on its present and future earning capacity. This is called its
intrinsic value or fundamental value. The purpose of fundamental analysis is to evaluate the
present and future earning capacity of a share based on the economy, industry and company
fundamentals and thereby assess the intrinsic value of the share. The investor can then
compare the intrinsic value of the share with the prevailing market price to arrive at an
investment decision. If the market price of the share is lower than its intrinsic value, the
investor would decide to buy the share as it is underpriced. The price of such a share is
expected to move up in future to match with its intrinsic value. On the contrary, when the
market price of a share is higher than its intrinsic value, it is perceived to be overpriced. The
market price of such a share is expected to come down in future and hence, the investor
would decide to sell such a share. Fundamental analysis thus provides an analytical
framework for rational investment decision-making. Fundamental analysis insists that no
one should purchase or sell a share on the basis of tips and rumours. The fundamental
approach calls upon the investor to make his buy or sell decision on the basis of a detailed
analysis of the information about the company, the industry to which the company belongs,
and the economy. This results in informed investing. The fundamental analysis can be
valuable, but it should be approached with caution. If you are reading research written by a
sell-side analyst, it is important to be familiar with the analyst behind the report. We all have
personal biases, and every analyst has some sort of bias. There is nothing wrong with this,
and the research can still be of great value. Learn what the ratings mean and track the
record of an analyst before jumping to a conclusion. Corporate statements and press
releases of a company offer good information, but they should be read with a healthy
degree of scepticism to separate the facts from the spin. Press releases don’t happen by
accident; they are an important PR tool for companies. Investors should become skilled
readers to weed out the important information and ignore the hype.
TECHNICAL ANALYSIS:
Fundamental analysis and Technical analysis are the two main approaches to security analysis.
substitute to it. According to technical analysis, the price of stock depends on demand and supply in
the market place. It has little correlation with the intrinsic value. All financial data and market
information of a given stock is already reflected in its market price. Technical analysts have
developed tools and techniques to study past patterns and predict future price. Technical analysis is
basically the study of the markets only. Technical analysts study the technical characteristics which
may be expected at market turning points and their objective assessment. The previous turning
points are studied with a view to develop some characteristics that would help in identification of
major market tops and bottoms. Human reactions are, by and large consistent in similar though not
identical reaction; with his various tools, the technician attempts to correctly catch changes in trend
Technical analysis is directed towards predicting the price of a security. The price at which a buyer
and seller settle a deal is considered to be the one precise figure which synthesis, weighs and finally
expresses all factors, rational and irrational, quantifiable and non-quantifiable and is the only figure
that counts
Thus, the technical analysis provides a simplified and comprehensive picture of what is happening to
the price of a security. Like a shadow or reflection it shows the broad outline of the whole situation
and it actually works in practice.
ASSUMPTIONS OF TECHNICAL ANALYSIS :
2. The demand and supply factors of a security are surrounded by numerous factors;
3. The security prices move in trends or waves which can be both upward or
or traders.
4. The present trends are influenced by the past trends and the projection of future
5. Except minor variations, stock prices tend to move in trends which continue to
6. Changes in trends in stock prices are caused whenever there is a shift in the demand
7. Shifts in demand and supply, no matter when and why they occur, can be detected
8. Some chart trends tend to repeat themselves. Patterns which are projected by charts
record price movements and these patterns are used by technical analysis for making
Industry Analysis
Company Analysis
Economic Analysis
# 2 You can make gains by purchasing an under-valued stock and then wait for the market to correct itself.
It is also a method of evaluating Securities. But the entire game here is dependent upon the statistics generated by the market. Charts and
patterns are the Bread and Butter of technical analysis.
This analysis uses past price movements to predict its future price movements.
Trends and Patterns play a major role, rather than the Intrinsic Value.
Market Price is everything. Factors affecting it are not considered, like in fundamental analysis.
Objectives of Fundamental Analysis
When the objective of the analysis is to determine what stock to buy and at what price, there are
two basic methodologies
1. Fundamental analysis maintains that markets may misprice a security in the short run but
that the "correct" price will eventually be reached. Profits can be made by trading the
mispriced security and then waiting for the market to recognize its "mistake" and reprice
the security.
2. Technical analysis maintains that all information is reflected already in the stock price.
Trends 'are your friend' and sentiment changes predate and predict trend changes.
Investors' emotional responses to price movements lead to recognizable price chart
patterns. Technical analysis does not care what the 'value' of a stock is. Their price
predictions are only extrapolations from historical price patterns.
Investors can use any or all of these different but somewhat complementary methods for stock
picking. For example many fundamental investors use technical’s for deciding entry and exit
points. Many technical investors use fundamentals to limit their universe of possible stock to
'good' companies.
The choice of stock analysis is determined by the investor's belief in the different paradigms for
"how the stock market works". Fundamental analysis includes:
1. Economic analysis
2. Industry analysis
3. Company analysis
On the basis of these three analyses the intrinsic value of the shares are determined. This is
considered as the true value of the share. If the intrinsic value is higher than the market price it is
recommended to buy the share. If it is equal to market price hold the share and if it is less than the
market price sell the shares.
The Three Golden Rules:
Second Rule: Price movements are not random. Trends behind the price action can be established by using Technical tools.
The basic belief is that as the company grows so will the value of the share increase. This in turn will benefit the
investor in the long run.
Once you look at the balance sheet and other financial details, you use ratios to compare the financials with the
price of the stock. This helps understand how much an investor is really paying in comparison with the company’s
growth. The most common ratio used is the Price-to-Earnings or PE ratio. This is computed by dividing the share
price with the company’s earnings per share.
If the share price in comparison with its earnings per share is less than industry average, then the stock is said to
be undervalued. This means the stock is selling at a much lower price than what it is actually worth.
Let us understand using an example
Suppose a company ABC earns Rs 50 per share. Its current share price is Rs 100. Its PE ratio is thus 2.
Suppose, the average PE ratio for the industry is 5, then the company is undervalued. If there is another
company in the same industry with a PE ratio of 10, then its stock will be considered to be overvalued.
However, an analyst expects the company to earn Rs 100 per share in the next financial year. Then the forward
PE would be 1.
This shows that the price is even more undervalued when you consider the company’s growth
Unlike fundamental analysis, technical analysis has nothing to do with the financial performance of the underlying
company. In this method, the analyst simply studies the trend in the share prices. The underlying assumption is
that market prices are a function of the supply and demand for the stock, which, in turn, reflects the value of the
company. This method also believes that historical price trends are an indication of the future performance.
Thus, instead of assessing the health of the company by relying on its financial statements, it relies upon market
trends to predict how a security will perform. Analysts try to cash in on the momentum that builds up over time in
the market or a stock
Technical analysis is often used by short-term investors and traders, and rarely by long-term investors, who
prefer fundamental analysis.
Technical analysts read and make charts of prices. Some common technical share market analysis measures are
the day-moving averages (DMAs), Bollinger bands, Relative Strength Indices (RSI) and so on
For example, if a stock of a company growing at 10% is selling at Rs 100 with a PE ratio of 10 and another stock
of company that also grows at 10% is selling at Rs 150 with a PE ratio of 15, the value investor would select the
first stock over the second. This is because the first stock is undervalued in comparison with the second.
Value investors see the potential in the stocks of companies with sound financial statements that they believe the
market has undervalued. They believe the market always overreacts to good and bad news, causing stock price
movements to not move in tandem with long-term fundamentals. For this reason, they are always on the hunt for
undervalued companies.
Value investors profit by taking a position on an undervalued stock (at a deflated price) and then profit by selling
the stock when the market corrects its price later. Value investors don't try to predict which way interest rates are
heading or the direction of the market and the economy in the short term. They only look at a stock's current
valuations and compare them to their historical range.
In other words, they pick up the stocks as fledglings and cash in on them when they are valued right in the
markets.
For example, say a particular stock's PE ratio has ranged between a low of 20 and a high of 60 over the past five
years, value investors would consider buying the stock if its current PE is around 30 or less. Once purchased,
they would hold the stock until its PE rose to the 50-60 ranges, before they consider selling it. In case they expect
further growth in the future, they may continue to hold.
How to conduct fundamental analysis?
Fundamental analysis is a method of analyzing and evaluating equities,
stocks, or other investment avenues. It is prudent to conduct a fundamental
analysis before planning for any investments
Checking the company’s website for information is the first way to know
about it. The website will host the details about the company, its
products, its objectives, as well as its promoters, board members, or
directors. These details can help the investor know whether the company
has a strong base.
· Company’s financials
Read the company's financials including its profit and loss statements,
balance sheets, cash flow statements, sales reports, and forecasts,
operating costs, expenses, etc. If its CAGR, sales, and profits data for the
past five years are on the increasing scale, then it should be a good sign
for the investor.
· Financial ratios
Financial ratios help assess a company's performance. They help with the
initial assessment of the company’s growth rate, profitability, revenue
generation, or dividend yields.
· Debt ratio
Checking the debt ratio of the company is one of the determining factors
before investing in its stock. As per the rule, a company having a debt
ratio less than 1 is a good investment. Companies with a higher debt ratio
cannot give long-term dividends to its shareholders, thereby making them
a bad investment
Every company will have competitors in their line of work. One should be
able to reason why they are investing in a particular company and not in
its competitor. The investor should also determine what sets this
company apart from its competitors: whether it has a Unique Selling
Point(USP), the features of its products, its prospects, its upcoming
products, and other factors
1. Interference
I would call this information noise. Technical analysis is very subjective. Quick changes in
schedules may have an adverse impact on the trading results. What may seem on the chart to
signal to enter the market, in fact will be only a noise, that can be tracked only on large frames.
It is possible to increase the accuracy of the signals by the number of indicators used, however,
it is not a panacea, because it reduces the number of entry signals into the market.
2. Controversial conclusions
How many people, so many opinions. Someone sees the cup half empty, some half full,
although the level’s one and the same! Technical indicators may show the signals. Different
traders may interprete exactly the opposite. Interestingly, both traders will find legitimate
confirmation of his conclusions, and even quite logical. Maybe that’s why the analysts at the
investment banks come true only in 60% of cases?
Unfortunately, Forex trading requires fast reaction. In addition to the fact that the signals can
be delayed, the trader may also be late in decision. By the way, regarding the lag the Dow
theory is often criticized.
4. Exceptions
Disadvantages of technical analysis are also evident in the fact that the figures and postulates
do not work 100%. Yeah, maybe you saw the build of the figure, but the external factors will
work , such as the volume of trades that negate a successful market entry or exit.
To sum up. Theory often diverges from practice. Each tool has its own characteristics, and it
works not in every situation. Only experience, only testing instruments on a demo account will
allow you to choose the optimal strategy. And, of course, be prepared for possible financial
losses!
Limitations of Fundamental Analysis:
Time Constraints
Fundamental analysis may offer excellent insights, but it can be
extraordinarily time-consuming. Time-consuming models often produce
valuations that are contradictory to the current price prevailing on Wall
Street. When this happens, the analyst basically claims that the whole street
has got it wrong. This is not to say that there are not misunderstood
companies out there, but it seems quite brash to imply that the market
price, and hence Wall Street, is wrong.
Industry/Company Specific
Valuation techniques vary depending on the industry group and specifics of
each company. For this reason, a different technique and model is required
for different industries and different companies. This can get quite time-
consuming, which can limit the amount of research that can be performed.
A subscription-based model may work great for an Internet Service
Provider (ISP), but is not likely to be the best model to value an oil
company.
Subjectivity
Fair value is based on assumptions. Any changes to growth or multiplier
assumptions can greatly alter the ultimate valuation. Fundamental analysts
are generally aware of this and use sensitivity analysis to present a base-
case valuation, an average-case valuation, and a worst-case valuation.
However, even on a worst-case valuation, most models are almost always
bullish, the only question is how much so. The chart below shows how
stubbornly bullish many fundamental analysts can be.
Analyst Bias
The majority of the information that goes into the analysis comes from the
company itself. Companies employ investor relations managers specifically
to handle the analyst community and release information.
Conclusion
Fundamental analysis can be valuable, but it should be approached with
caution. If you are reading research written by a sell-side analyst, it is
important to be familiar with the analyst behind the report. We all have
personal biases, and every analyst has some sort of bias. There is nothing
wrong with this, and the research can still be of great value. Learn what the
ratings mean and the track record of an analyst before jumping off the deep
end. Corporate statements and press releases offer good information, but
they should be read with a healthy degree of skepticism to separate the facts
from the spin. Press releases don't happen by accident; they are an
important PR tool for companies. Investors should become skilled
readers to weed out the important information and ignore the
hype.