Technical and fundamental analysis compared: strengths and weaknesses
If you want to invest in stocks, it’s important to understand how to evaluate a company to choose which stocks to target. Investors have two main tools for studying companies: fundamental analysis and technical analysis. Let’s look in detail at how they work and what are the pros and cons of each method.
What is fundamental analysis
Fundamental analysis studies all available data on a company, such as revenue, debt, and market position. The goal is to understand if the company is solid and has positive growth prospects.
For example, if Apple reports increasing sales and profits year after year, analysts may predict that this trend will continue into the future. As a result, Apple’s share price should rise as the company grows.
Analysts examine in detail:
- Financial data such as balance sheets, revenues and profits from recent years
- Management and business strategies to understand if they are moving in the right direction
- Industry in which the company operates, market share and competitors to assess its competitiveness
In this way they estimate how much the company could earn in the future. The more positive the forecasts, the more the stock price should rise in the long run.
Advantages of fundamental analysis
- Assesses the real health of the company and its future prospects
- Does not follow fleeting fashions and emotional market fears
- Identifies undervalued stocks whose price could rise significantly
Disadvantages of fundamental analysis
- Requires a lot of time and specific skills to decipher the data
- Market prices may diverge from estimated values for even long periods
- Forecasts about the future could turn out to be completely wrong
What is technical analysis
Technical analysis is based on charts and trading volumes of stocks to identify trends and possible turns already underway.
For example, if the price of a stock has been steadily rising for several months, technical analysis can detect this trend and predict it will continue in the near future as well.
Analysts observe:
- Historical trends to identify bullish or bearish trends and significant price levels
- Volumes traded day by day, to understand investors’ interest and emotions
- Technical indicators that signal possible trend reversals in advance
In this way they try to predict whether prices will rise or fall in the short to medium term.
Advantages of technical analysis
- Quickly recognizes short-term profit opportunities by leveraging ongoing trends
- Based on objective and easily observable market data
Disadvantages of technical analysis
- Buy/sell signals can often prove wrong leading to losses
- Predicts only direction, not precise extent of price movements
- Works best in the short term, less so for long term investments
Which one to choose?
Fundamental analysis is more suitable for those who want to invest long-term targeting solid companies. Technical analysis is more appropriate for those who trade short-term exploiting price fluctuations.
More prudent investors can combine both techniques to get the most complete picture possible before deciding where to invest.