Fundamental and Technical Analysis: What is the Difference?

by | Investment Basics

Fundamental vs. Technical Analysis

We’re going to examine the difference between fundamental and technical analysis. Most investors, if they understand the differences, believe they are one or the other.

In reality, most investors use a combination of the two types of analysis. Personally, I consider myself a 90% fundamental and 10% technical investor.

As a fundamental investor I believe investment decisions should be based primarily on value versus price. Purchasing an investment whose price is less than its value greatly improves the odds of above average rates of return on investment.

Fundamental Stock Analysis

Fundamental stock analysis is the process of financial statement analysis; an examination of company products, management, competitors, markets, and economic environment to determine the value of its stock. Both historical and present data can be used, with the goal being to forecast how the stock will perform in the future.

The most common data used in fundamental research and analysis would be revenues, expenses, profits, earnings per share, assets, liabilities, book value, dividends, cash flow, and projected earnings growth rates. Key ratios would include price/earnings ratio (P/E), dividend yield, dividend payout ratio, return on equity, price to sale, and price to book value.

An analyst would evaluate the data and ratios in comparison to the universe of stocks available. The goal of the investor is to invest in those companies with the best prospects given the current price.

If you are interested in dividend stocks you will want to read Selecting Dividend Stocks with the Dividend Analyzer. This page will show you how to perform fundamental analysis of dividend stocks.

Technical Analysis

Technical analysis is the forecasting of the future price of a financial asset using primarily historical price and volume data. Technical analysts believe that all information is reflected in the price; making fundamental analysis unnecessary. Information from the analysis of price is used to predict what the future price will be.

There are several different popular schools of technical analysis, including Elliott Wave Theory, Dow Theory, and Candlestick Charting. All attempt to use price patterns and price trends to make forecasts of future prices. The central idea is to estimate the likelihood of price movements and make trades based on those with the best risk/reward ratio.

When evaluating price, technicians frequently use overall trend, areas of support and resistance on the charts, price momentum, volume to determine buy/sell pressure, and relative strength compared to the market. They would also look for price patterns, study moving averages, and examine indicators such as put/call ratios.

Fundamental or Technical Analysis?

Using both fundamental and technical analysis makes sense. Both provide information that adds insight into investment analysis. I don’t believe technical analysis alone can provide the information needed to make investing decisions.

I always use fundamental value analysis first; then I might use technical analysis to look for good entry and exit points. If both analyses give the same answer, then I have a higher level of probability for my investment decision. If fundamental and technical analyses offer different answers then I might be more patient and wait to execute my order.

Remember, you don’t have to invest in an asset until the odds are heavily in your favor. Because of the differences between fundamental and technical analysis, using both can increase your probability of making wise investment decisions.

Additional Reading: Investment Portfolio Management Basics: Risk, Asset Allocation, & Investing Strategies

 

Value Investing Portfolio Management Guides

Arbor Asset Allocation Model Portfolio: AAAMP Global Value Portfolio, Trade Alerts

Dividend Value Builder: DVB Analyzer Newsletter, Treasure Trove Twelve Newsletter, DVB Portfolios Newsletter

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Disclaimer
While Arbor Investment Planner has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability, or completeness of third-party information presented herein. The sole purpose of this analysis is information. Nothing presented herein is, or is intended to constitute investment advice. Consult your financial advisor before making investment decisions.

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