When looking at a possible stock to buy, investors often use fundamental analysis or technical analysis to determine whether or not they should buy the stock. Both methods of analysis have their advantages and disadvantages, and it usually comes down to whatever you feel more comfortable with. So, what is fundamental analysis and technical analysis?
Fundamental analysis is a method used by investors to determine the actual value of a stock. Investors are looking to find what they believe the intrinsic value of the stock, and then conclude whether the stock is undervalued or overvalued. When performing fundamental analysis, the investor looks at key financial numbers and indicators. These include the cash flow in the company, the company’s earnings-per-share, revenue increase, and profit margins. Fundamental analysis does not focus on the price and trading movements of the security, but rather the underlying company. Warren Buffett is a well-known example of a fundamental analyst.
Technical analysis is a method used by investors to evaluate stocks and try to forecast their future trends. Investors are looking to find patterns and indicators in trading data and historical performance to determine whether the stock will increase in price or decrease in price. When performing technical analysis, the investor looks many factors in the trading data, such as trade volume and price changes. Technical analysts also look for a variety of patterns (more on those here) in performance charts, such as sudden reversals and price gaps. Technical analysis focuses less on the underlying company and more on the security itself. Jason Perl is a successful technical analyst.
Which is Better?
The “better” form of analysis depends completely upon what you believe. Some people prefer the financial stability found in fundamental analysis, while others put more faith in the traders. No one method has a clear advantage over the other, but there are two important characteristics that we’d like to mention:
- Fundamental analysis is typically used for the long-term, while technical analysis is typically used for the short- and mid-term
- Technical analysis usually requires at least some historical performance and previous trading; meanwhile, fundamental analysis requires the company to be more mature and have accurate financial numbers and ratios
Both methods of analysis have critics, and both methods have investors who swear by it. Whichever form you use is up to you. In fact, you don’t even have to stick to these guidelines – there are plenty of ways to determine whether or not to buy a stock. It all depends on your financial situation and how long you plan on holding the security. Personally, I prefer fundamental analysis. Fundamental analysis ensures that you are investing in a quality company that will perform well for the long term. However, many short-term traders would probably disagree with my preference. Again, it’s all up to you.