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What is Fundamental Analysis?
Fundamental Analysis is the process to find out “intrinsic value” of a stock based on real factors behind the company. These factors include the macro-economic situation, the quality of management, the business environment and the financial situation of the company.
Once the intrinsic value of the stock is determined, it can be used to determine if the stock is available at a fair price or the stock is costly. e.g. If the intrinsic value is more than the market price of the stock, that means that the stock is available at a discount.
On the other hand, if the market price is higher than the intrinsic value, that means that the stock is priced more than its fair value.
Fundamental Analysis is typically used by long term investors who are not looking for immediate returns or rather who do not mind holding the securities for a longer period of time.
This is because the true value of a stock increases gradually over a period of time, however market sentiments may push the price 20% up or down in a week.
What is Technical Analysis?
As we already discussed, Fundamental analysis is about finding out the fair value of stock and benefiting from it if the market price is lower than the fair value. Technical Analysis on the other hand is another way of analyzing stock price movements.
Technical Analysis tries to predict or determine the price trend of a stock purely based on demand and supply. A technical analyst looks at the chart of an equity for current price and then based on historical price movements (demand and supply) around the current price, tries to predict the movement of the price. So, in essence, the technical analyst is just concerned about the price and not about the reasons of why the price of an equity is what it is.
Technical Analysis is built around the three theorems laid down by Charles Dow.
Charles Dow’s 3 Theorems:
- Price discounts everything (don’t bother about fair value, the market value of the stock is the fair value, with everything built in)
- Price movements are not totally random (there periods of trends in charts interspersed with some random behavior)
- What is more important than why (what is happenning in the market and to the price of the stock is more important than why it is happenning)
Based on the price movements, several patterns and indicators have emerged, which work to varying degrees for various stocks. It is important to note that a pattern which works well in predicting the price movements of one stock might not work as accurately for another stock. At times, many patterns are used in tandem to study and predict price movements.