Similarities and Differences Between Technical And Fundamental Analysis
Technical analysis and fundamental analysis are two concepts that new investors often come across when they learn to trade. Some are passionate about technical analysis, others about fundamental analysis; yet few manage to master both with skills. In this article, I’ll highlight similarities and differences between both subject areas.
Technical analysis is concerned with price action
Technical analysis is the study of “price action”, a fancy word which describes how a security’s price and volume have changed over time. For example, Amazon’s price action is focused on changes in Amazon’s share price, as well as trading volumes. Technical analysis isn’t limited to stocks – it can be applied to foreign exchange, crypto-currencies, commodities and bonds for example.
Prices rarely form a random walk. Instead, they tend to form patterns that can last from days to years in some cases. The “head and shoulders pattern” and the “double top pattern” are notoriously bearish patterns. Conversely, the “double bottom pattern” and “rounded bottom” are well known bullish patterns.
Technical analysis places considerable importance on the study of these patterns. Some patterns, known as continuation patterns, indicate that a price trend is likely to continue. Whereas others, known as reversal patterns, suggest that a change could occur soon.
If you’d like to find out more about chart patterns, I recommend this chart patterns pdf. It was published recently by TrustedBrokers and flags chart patterns across a number of popular names, like GME, Netflix, Bitcoin and Matic. It’s also free to download, which is a nice touch.
Fundamental analysis is concerned everything else
Fundamental analysis is focussed on understanding a company’s business inside out, as well as the factors that could affect its share price. Many investment professionals consider fundamental analysis to be the most important step in the investment process.
Examining a company’s financial health, future growth prospects, brand strength, and the quality of its management team will help you determine whether the company’s stock is undervalued, overvalued or trades at fair value. This is the process that equity research analysis undertake, which leads them to issue buy, sell or hold recommendations.
If you were to understand fundamental analysis, you’d usually start by analysing a company’s financial statements. These include the company’s balance sheet, profit and loss account and cash flow statement. As financial statements are backward-looking, you should also review press releases to understand whether anything has changed in the recent past.
The best investment professionals understand both technical analysis and fundamental analysis. Chart patterns can have strong predictive value, but ultimately need to be underpinned by fundamentals.