Whether it’s a long-term holding, short-term investment, or trading opportunity, you need to analyze the markets and financial assets before putting your money in the game. Based on your goal, you can study the markets in different ways and find potential assets that suit your strategy.
Technical Analysis and Fundamental Analysis are the main go-to methods for traders and investors to gauge an asset and its performance to decide on the amount of capital they wish to invest, their investment period, and risk exposure.
In this article, we will take a look at the technical and fundamental analysis and their differences and will briefly cover some of the metrics you can use while performing each.
Simply put, technical analysis is the process of examining the markets based on previous price movements or price history. The main idea is that the price in financial markets usually follows certain patterns over time. If we recognize those patterns in the current market, we will be able to predict the direction the market is headed in the near, mid, or long term.,
Therefore, technical analysis is the study of price history and market statistics to predict the future price movements of a financial asset. Through various indicators and oscillators, technical analysis helps traders and investors to have better market estimations.
Charles Henry Dow, the founder of The Wall Street Journal and Dow Jones & Company, is the main brain behind the technical analysis. Born in 1851, Charles started his career as a financial journalist, studying companies.
He started to recognize that stocks tend to move in a specific direction. He published his ideas in a series of articles in The Wall Street Journal which are known collectively as the Dow Theory.
Unfortunately, Charles never had a chance to publish his ideas as a distinct theory himself, and his editorials were put together by other editors into the Dow Theory we know today. His theory is the foundation of the technical analysis we know today.
According to the Dow Theory, market prices reflect the overall economic condition as every aspect of businesses is priced into the current market. Charles also believed that markets go through three different trends:
Charles also created the Dow Jones Transportation Index (DJT) in 1884, which is known as the first stock index. The index tracked the shares of 11 transportation companies, primarily focused on railways as they were the main transportation system at the time.
Fundamental Analysis focuses on the intrinsic value of a specific asset and estimates this value through different means. To analyze an asset, you would primarily look at the overall economic situation or the strength of the industry to see how they would affect the markets.
Let’s consider the fundamental analysis in the stock market: the financial information regarding a company such as revenue or profit margin is used in fundamental analysis to assess the true value of its stocks. The industry is another factor to consider. For instance, if there is a shortage in the chip market, you can expect the stocks of the tech companies to be affected.
An interesting assumption in fundamental analysis is that the markets will price in the fundamentals later on. Based on this, an investor would have the chance to invest in an asset from the early stages and benefit from the price increases as the asset reaches its true value later on.
Here are a few key differences between technical and fundamental analysis:
Technical analysis makes use of charting tools and different indicators to analyze the markets and forecast the future direction of the prices. Fundamental analysis, on the other hand, looks at the economic data or financial statements of specific companies to analyze the intrinsic value of assets or how they would perform in current market conditions.
Fundamental analysis mostly looks at long-term data and is used for long-term investments while with technical analysis, traders can work with short-term timeframes, even in minutes, to benefit from short-term price movements.
Technical analysis is mostly used for trading purposes where traders use charting tools in their short or mid-term trading strategies to profit from price fluctuations. On the flip side, fundamental analysis is used by investors who look for potential assets whose market price is below their intrinsic value. By discovering and investing in these assets, investors will have the chance to enjoy future price appreciation of the asset as early investors.