Many analysts use a combination of the two to try and arrive at an appropriate strategy.
Most experts maintain that the long-term view on equity markets is intact, the short-term view is not so positive. While long-term view on equity is a product of fundamental analysis of the economic and corporate environment, short-term view is largely a product of analysing near-term price movement. The latter is popularly termed as technical analysis. Fundamental and technical analysis of a security can be very different, but they must co-exist.
This essentially estimates the change in the price of a security in the very near term, say, a week or a month, based on the security’s past price and volume data. Technical analysts use statistical tools and methods to plot charts from historical data. They further build on this to establish price trends and patterns, which may be repeated in the future. There are certain patterns like double tops/bottoms, flags and head and shoulders, to name a few, which analysts rely on. They also calculate the average prices of defined past periods and plot the resistance level (a price above which a security is unlikely to rise soon) and support level (a price below which it is unlikely to fall soon) to determine the near-term price range for a security. Alongside the price data, such analysis also plots volume data for the underlying security.
The very nature of this analysis is such that it will not be able to tell where the security’s price will be, say, a year from now or any period more than that. This happens because technical analysis is not equipped to judge the impact of long-term external events on market sentiment and earnings.
As opposed to technicals, fundamental analysis relies on a careful scrutiny of a company’s financial statements, future earnings potential and analysing the impact of various external and internal events on earnings growth. Based on this analysis, a projection of the future value or the price of a stock is made. This price target can be achieved after a year, two years or even later. The nature of this kind of analysis is long term because the information used for the analysis is spread out over time.
It’s on the basis of a company’s future earnings that fundamental analysis decides what an investor should pay for its stock today.
Technicals versus fundamentals
Technical analysts believe that any information relevant to a security’s value and available in the public domain is already reflected in the market price, hence they don’t see the need to analyse in detail the working of a company. Fundamental analysts, on the other hand, try to determine whether a security is trading at its fair price based on the company’s earnings and how the earnings can grow in the future and what impact it will have on the market price. This is why technical analysis is used for trading in the short-term, whereas fundamental analysis is more synonymous with long-term investing. It’s not always one or the other, as many analysts use a combination of the two to try and arrive at an appropriate strategy.