Investment strategy formulation (Technical vs.

Fundamental analysis)

Introduction

The success of any investment depends on the implementation of a reliable investment

model. The investment model encompasses the following elements: investment behavior,
investment strategy, market consideration, investment platform, and investment tools. The focus
of this diary will be on the investment strategy, what are the foundation of a successful
development of investment strategy. The role of investment behavior, and how it will affect
investment decision.

The most important factor that contributes toward the success of the implementation of
the investment model, is the investor behavior. The investment behavior of the investor requires
the individual to have the discipline and the emotional stability to deal with the market volatility,
while minimizing any irrational investment decisions as a result of change in the investment
environment. The other important factor is developing the of an appropriate investment strategy
that will be enable the investor to generate revenue streams from the investment venture within
the intended time horizon.

Investment strategies
It can be described as a set of rules, behaviors and procedures, designed with the aim of
providing the criteria that will be used by the investor to select investment instruments in the
investment portfolio. Risk appetite is the major determining factor for the criteria of investment
instrument selection .the relationship between risk and return tends to be positively correlated.
The higher the risk of default /loss of a specific investment instrument, the higher the expected
return that should be expected for investing in this instrument. I.e. junk bonds. On the contrary
risk averse attitude, discourages taking excessive risk in exchange of higher return on the
investment portfolio. The stance is typically demonstrated in the investment decisions made by
pension funds in particular.

The process of making an investment decision, requires two categories of meticulous

analysis .First type of analysis is Fundamental analysis. It is the process of analyzing the

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financial statements to measure the financial health of the investment, the benchmark for the
results of the financial statement analysis is industry accepted financial ratios .the analysis of the
management decisions, the behavior of the members of the board of directors is also within the
scope of the fundamental analysis. Competitive advantages of the business is required to
determine whether the company in question can be profitable on the long term or not. When
applied to forex investment instruments, the focus of the analysis will include: the overall state of
the economy, interest rates, Gross domestic product, debt to GDP ratio, and Central bank
policies. According to ( waring 2008) When analyzing a stock, futures contract, or currency
using fundamental analysis there are two basic approaches that can be applied one is The top-
down approach : when the investor starts his analysis with global economics, including both
international and national economic indicators, such as GDP growth rates, inflation, interest
rates, exchange rates, productivity, and energy prices. He narrows his search down to
regional/industry analysis of total sales, price levels, the effects of competing products, foreign
competition, and entry or exit from the industry. Only then he narrows his search to the best
business in that area. On the other hand , The bottom-up investor starts with specific businesses,
regardless of their industry/region.( Graham; Dodd 2004)

The second type of analysis is the Technical analysis, it is a technique that has the ability
to forecast the future direction of prices based on historic market data, trading price and volume.
In its purest form, technical analysis considers only the actual price and volume behavior of the
market or instrument. Technical analysts, employ models and trading rules based on price and
volume transformations, such as the relative strength index, moving averages, regressions, or,
classically, through recognition of chart patterns. Technical analysis focus only on price/ volume
charts to forecast the price of the investment instrument. Unlike the fundamental analysis,
whereas fundamental analysis will include the financial information of the investment
instrument, and the study of economic factors that influence prices in financial markets.
Technical analysis regards prices as the only true reflector all the elements that influences the
instrument price. Technical analysts (or technicians) seek to identify price patterns and trends in
financial markets and attempt to exploit those patterns. While technicians use various methods
and tools, the study of price charts is the key focus.

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 Technical analysts use quantitative indicators, which are typically mathematical
transformations of price or volume. These indicators are used to help determine whether an asset
price direction. Technicians also look for relationships between price, volume and open interest.
Examples include the relative strength index, and MACD. Other technicians include sentiment
indicators, such as Put/Call ratios and Implied Volatility in their analysis. There are several
schools of technical analysis. Adherents of different schools (for example, candlestick charting,
Dow Theory, and Elliott wave theory) may ignore the other approaches, yet many traders
combine elements from more than one school. Technical analysts use judgment gained from
experience to decide which pattern a particular instrument reflects at a given time, and what the
interpretation of that pattern should be.

Technical or Fundamental analysis

Relaying on technical analysis is the most convenient method for forecasting investment
instrument price direction, it is quantitative analysis based on easily accessed historical data, the
usage of charts helps to customize data parameters to enable macro view on the performance of
the instrument, unified set of data that every analyst/ trader can access & analyze minimizes the
risk of insider trading. Technical analysis knowledge can be easily transferred, but experience
plays a crucial role for producing reliable analysis.

Fundamental analysis, is much harder to master in comparison to technical analysis. The

diversity of factors of that are qualitative in nature, poses as a challenge for analysts. The
capability to determine that a specific factor will have an impact on the instrument can be
obtained. The knowledge to interpret the qualitative nature of the fundamental raw data, to a
quantitative effect of this event on the instrument is challenging. Ex. The effect of political
instability in Middle Eastern crude oil producing countries on the global economic growth
forecast. Performing fundamental & technical analysis is done by the investment banks, where
dedicated resourceful teams can data mine raw data and provide comprehensive reports. On the
individual trader level, performing both analysis is impractical, most prefer technical analysis
although fundamental analysis provides insights that technical analysis can’t capture.

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 References

Graham, Benjamin; Dodd, David (December 10, 2004). Security Analysis. McGraw-

Hill. ISBN 978-0071448208.

Waring, David ,  "An Introduction to Fundamental Analysis and the US Economy" .

InformedTrades.com. date of publish :2008-02-14. Date of access: 25-11-2011.