Fundamental vs Technical Analysis: What's the Difference?

What Is Fundamental Analysis?

Fundamental analysis looks at a company's financials, its business performance and its inherent value. The objective is to determine whether the stock is trading at a price that is appropriate for the business.

Analysts examine several factors, including:

• Revenue and profit: are sales and profits up, down or flat?
• Debt and cash flow: can the company service its debt and generate cash from its operations?
• Valuation ratios (e.g. the P/E ratio) are useful in comparing a company's valuation to its earnings and in some cases to that of similar companies.
• Business outlook: future performance is subject to industry trends, the competitive landscape, management decisions and the state of the economy.

For instance an investor looking at a manufacturing company would look at its annual reports, its profit margins, its level of debt and its expansion plans before coming to a view on whether or not to invest.

Fundamental analysis is of course the domain of long term investing as it takes time for a company's performance to be reflected in the share price. It can however be of use in the shorter term too, particularly around the time of an earnings announcement or a major business event.

One caveat is that even a very strong company can be a very expensive investment if the share price already reflects very high expectations. The financials can change and future performance is never assured.

What Is Technical Analysis?

Technical analysis is all about price action, volume and chart patterns in order to identify potential trends and trading opportunities. It's not really about the company's financial statements at all, it's about studying how the market has behaved.

Common tools include:

• Candlestick charts: Display the opening, closing, high and low prices over a period.
• Support and resistance: Find the price levels where support or resistance has previously been encountered.
• Moving averages: These help you to look at the direction of a price trend over time.
• Relative Strength Index (RSI) measures the speed and the magnitude of recent price movements.
• Trading volume: The number of shares or contracts that have traded during a period.

Imagine a stock trading near Rs 500. The stock has been repeatedly struggling to get above Rs 520 and volume is building as it approaches that level. The trader might be watching for a breakout above Rs 520 or a rejection of that level before making a decision.

Technical analysis is used extensively in intraday trading, swing trading and all the other forms of trading that are based on price action. Chart patterns and indicators in themselves are not a reliable form of prediction though. A false breakout, a surprise piece of news or a very volatile market can all render a trading setup completely invalid.

Fundamental vs Technical Analysis: Key Differences

The key difference is what each method looks at.

1. Primary focus: Fundamental analysis looks at the business, the financial position and the valuation of the company. Technical analysis looks at price action, trends and trading activity.

2. The normal time horizon: Fundamental analysis is typically employed in making investment decisions over a period of months or years. Technical analysis is more often used for shorter term trading, though it can be used to support longer term decisions as well.

3. Information used: Fundamental analysts use financial statements, company announcements, industry developments and valuation measures. Technical analysts use charts, price data, volume and indicators.

4. Main objective: Fundamental analysis is about assessing the underlying value of the business and the prospects of the business. Technical analysis is about trying to find potential entry and exit points and identifying changes in direction.

5. Key limitation: Fundamental analysis can't tell you exactly when a stock's price is going to go up. Technical analysis can't guarantee that a historical price pattern will repeat itself.

Neither approach gets rid of risk and both of them will require independent judgement.

Can You Use Both Methods Together?

Yes. Some investors will use fundamental analysis to shortlist the companies and then use technical analysis to work out when to get in and when to get out.

For example an investor might spot a company with steady earnings, manageable debt and a sensible valuation. Before buying they'd look at the price chart to get a feel for the current trend and establish a potential entry point.

This may give you a wider perspective but doesn't necessarily lead to better returns. A company with excellent fundamentals can still see its share price go down and a chart pattern that looks very promising can quite simply fail to materialise.

Platforms like the Ashika Dhanush app can be used to track share prices and get market related information for your own research. As always the investor needs to check the company information for themselves and be aware of the limitations of any analytical tool.

Which Approach Should Beginners Choose?

The answer is very much dependent on the objective. If you're building a portfolio over the long term you're likely to want to start with the financial statements, the company's performance and valuation. If you're looking at trading for the short term you're probably going to need to learn about chart reading, order execution and risk management.

Whatever method you go for, don't rely on a single ratio, a single indicator or a social media 'tip'. Set your objectives clearly, get a proper understanding of your own financial position and consider the very real possibility of loss prior to making any decision.