If you are an investor you must have come across two terms quite frequently, which are Technical Analysis and Fundamental Analysis. Here I am going to present a brief explanation of both of these methods and will highlight some of the key differences.
Technical Analysis deals with the evaluation techniques, which are based on past stock prices and trends. In technical analysis we look at how a stock has performed in past and how has the different factors affected the price of that stock. We use different statistical methods and techniques to evaluate stocks. Based on all these prices we predict that how this stock is going to perform in future, what is the price of this stock going to be in future. We use different statistical techniques like regression, simulation etc. to calculate future returns. These methods also use some financial models and techniques to evaluate future returns.
In technical analysis we use price-based rules like moving averages, regression, relative strength index, business cycle, inter market and intra market pricing, and stock market cycles.
Whereas fundamental analysis, as the name suggests is applied at a fundamental level. It is applied to calculate the value of firm. It recognizes the current value of firm based on different factors and also considers probable variations because of some past trends. It looks at the value base on what the future aspects of the firm are going to be, and what are the opportunities over which the firm is going to capitalize in future. It also deals with threats, which a firm is facing, which can take the value of firm down in future. Based on all these factors, total value of a firm is calculated that is further used to calculate the value of firm’s stock.
Technical analysis is mostly used for securities and stock analysis as opposed to fundamental analysis, which deals with facts of company, market, commodity, and currency, while technical analysis analyzes just prices. For a good stock analysis, it is necessary to have both technical and fundamental analysis; that’s why all the good brokerage firms, trading groups and financial institutions have both fundamental and technical analysis teams.
Technical analysis is a widely used technique by financial professionals and traders and is mostly used by active day traders, pit traders and market makers. It was widely criticized in 1960s and 1970s by academics. Some of the recent studies have found that it gives positive results in 56 out of every 95 cases but there are also reported some other issues as well. Some of the very good academics say that is not consistent with the weak form and efficient-market hypothesis. But those in favor of technical analysis say that even if it does not predict future it does give some insight about trading opportunities. Based on all this it can be said that both of these techniques have their own shortcomings, and it is recommended to use both the techniques together.