We must have come across many situations in life about comparing two different approaches and finding out which one is better. Some situations that we have gone through like…
Is commerce stream or Science stream better? Is love marriage or arranged marriage good? Is a Job or business is better? Is buying a house or renting it better?
Have you found any universal answer to this? Well, it is different from person to person or situation to situation. But we need to understand their pros and cons.
Likewise, let’s understand the pros and cons of Technical Analysis Vs Fundamental Analysis and what I feel about these two approaches after the decadal experience.
Technical analysis and fundamental analysis are two methods of analysing financial markets and securities, including stocks, currencies, commodities, and other tradable assets. While both approaches aim to help traders and investors make informed decisions, they differ in their focus and methodology.
What is Technical Analysis?
Technical analysis is a method of evaluating securities by analysing statistical trends and market activity, such as price and volume, to identify patterns and make predictions about future price movements.
The central assumption behind technical analysis is that historical price data can be used to predict future price movements. This approach involves studying charts, identifying patterns, and using technical indicators such as moving averages, Relative Strength Index (RSI), and MACD, to analyse market trends and identify potential buying or selling opportunities.
Advantages of Technical Analysis
Technical Analysis offers a lot of benefits to traders that apply it.
- Technical analysis is more objective than fundamental analysis as it relies on price data and market activity rather than subjective opinions and forecasts
- Technical analysis is useful for short-term trading and identifying entry and exit points in a trade
- Technical analysis can be applied to any asset that has a price and trading history
Disadvantages of Technical Analysis
- Technical analysis does not consider the underlying value of the asset or the economic and industry factors that can influence its price movements
- Technical analysis can be subjective and prone to interpretation, leading to different analysts reaching different conclusions
- Technical analysis cannot predict sudden or unexpected events that can disrupt market trends, such as natural disasters or political crises
What is Fundamental Analysis?
Fundamental analysis is a method of evaluating securities by examining the underlying economic and financial factors that affect their value. This approach involves analyzing financial statements, industry trends, macroeconomic indicators, and other quantitative and qualitative data to determine the intrinsic value of an asset.
The central assumption behind fundamental analysis is that the market can be irrational in the short term, but will eventually reflect the true value of an asset over the long term.
Advantages of Fundamental Analysis
- Fundamental analysis takes into account the underlying value of the asset and its future potential earnings and growth prospects
- Fundamental analysis can help identify undervalued or overvalued assets and identify potential long-term investment opportunities
- Fundamental analysis is less prone to sudden market fluctuations and is more suited to long-term investment strategies
Disadvantages of Fundamental Analysis
- Fundamental analysis can be time-consuming and requires a deep understanding of the company and industry being analysed
- Fundamental analysis may not be applicable to assets that do not have a strong fundamental basis, such as cryptocurrencies
- Fundamental analysis can be influenced by subjective judgments and assumptions, leading to different analysts reaching different conclusions
My Learnings As a Trader
I believe, traders should have a command of technical analysis followed by fundamental and Vice versa for investors. Technical analysis should be used in instruments where high participation and volumes are happening. For example, technical analysis works well in Nifty’s top 300 stocks but will not be much effective in micro caps.
In conclusion, technical analysis and fundamental analysis are two complementary approaches to analyzing financial markets and securities. Traders and investors can benefit from using both methods to gain a more comprehensive understanding of the market and make better-informed decisions.