Technical and Fundamental Analysis: An Introductory Guide

Introduction

When you decide to invest your money, whether it’s in stocks, bonds, or other assets, making informed choices is crucial. To navigate the complex financial markets effectively, understanding different analytical approaches is key. This is where investment analysis comes in, with its two main disciplines: technical and fundamental analysis. Essentially, investment analysis is the process of studying information to evaluate an asset’s potential, understand its risks, and predict its future performance. Skipping this step is like navigating in the dark.

Indeed, in the world of financial markets, there are two main schools of thought, two distinct approaches to analyzing investments: Technical Analysis and Fundamental Analysis. Although they sometimes seem opposed, they actually look at the market from different perspectives.

In this introductory article, we will explore the basic principles behind both technical and fundamental analysis. Our goal is to provide you with a clear overview of what they are, what they study, and how they differ, laying the groundwork to understand how investors try to make sense of the complex financial markets.

Technical Analysis: Reading the Market from Charts

Following the introduction, let’s dive into the first of the two disciplines: Technical Analysis. The fundamental concept behind technical analysis is that past movements of a financial instrument’s prices and volumes (i.e., the quantity of shares or contracts traded in a given period) can help predict its future trends. This approach focuses exclusively on market activity – that is, prices and trading volumes – rather than the asset’s intrinsic value.

In fact, technical analysts primarily study charts, which represent the historical price movements. They seek to identify “patterns” (recurring shapes) and trends that, according to their theory, tend to repeat over time due to market psychology. Furthermore, they use a variety of technical indicators (such as moving averages, RSI, MACD, etc.), which are mathematical calculations based on price and volume data, to generate buy or sell signals.

The central idea is that the market price “discounts everything”: that is, it incorporates all relevant information (economic news, earnings expectations, investor sentiment, etc.). Therefore, analyzing the price itself is considered sufficient for making investment decisions.

However, it’s important to note what technical analysis does not consider. This approach ignores the intrinsic value of the company (it doesn’t look at financial statements or fundamentals), general economic data, or specific news about the asset. It relies solely on price action and market behavior.

Fundamental Analysis: Valuing True Worth

While technical analysis focuses on the market and price, fundamental analysis adopts a completely different perspective. Its primary objective is to determine the “intrinsic value” of a financial asset, meaning what it’s truly worth beyond short-term price fluctuations. Consequently, this approach is particularly popular among long-term investors.

But what exactly do fundamental analysts study? Instead of looking at charts, they delve into economic and financial data. They thoroughly analyze a company’s financial statements (Balance Sheet, Income Statement, Cash Flow Statement) to understand its financial health, revenues, profits, debts, and assets. Furthermore, they consider the overall economic context, the conditions of the industry in which the company operates, the quality of its management, and other qualitative factors that can influence its future performance.

The underlying idea is that an asset’s market price doesn’t always reflect its true value. This means that there might be times when the price is undervalued compared to its intrinsic worth (a buying opportunity) or overvalued (a signal to sell or avoid purchasing).

Consequently, fundamental analysis tends to ignore or give less weight to short-term price movements and immediate market sentiment, which are central to technical analysis. Instead, it focuses on the long-term solidity and prospects of the asset or company.The core difference between technical and fundamental analysis lies in this very point.

Technical vs. Fundamental Analysis: Two Different Approaches (But Complementary?)

We’ve seen that technical and fundamental analysis look at the market and investments from very different perspectives. The key difference lies in their objectives and typical time horizons. Technical analysis is often used for short- to medium-term investment decisions, aiming to predict immediate price movements based on chart patterns and indicator signals. Conversely, fundamental analysis is geared towards the medium to long term, aiming to identify undervalued or overvalued assets expected to reach their intrinsic value over time.

This marked difference leads many to consider the two approaches as opposing schools of thought. However, many experienced investors argue that technical and fundamental analysis do not necessarily exclude each other, but can indeed be used in a complementary way.

For instance, a fundamental investor might use fundamental analysis to select a solid company with excellent long-term prospects that they believe is undervalued. Subsequently, they might turn to technical analysis to identify the best time to enter the market, looking for confirming signals on charts that indicate an imminent trend reversal or a breakout. In this way, fundamental analysis helps decide what to buy (or sell), while technical analysis helps decide when.

Technical and fundamental analysis : Conclusion

In this introductory article, we’ve taken a first step toward understanding two of the pillars of investment analysis. We’ve seen that technical analysis focuses on “how” and “when” to invest by looking at market data like prices and volumes, seeking patterns and trends in charts. On the other hand, fundamental analysis aims to uncover the “why” and “what an asset is truly worth”, by studying the issuer’s financial, economic, and qualitative data.

It’s clear that both approaches offer valuable tools for making more informed investment decisions. There isn’t one “better” method; the choice (or combination) depends on the investor’s goals, time horizon, and personal investment philosophy.The synergy between technical and fundamental analysis can provide a powerful edge.

As mentioned at the outset and reiterated now, in the upcoming articles of this series, we will delve much more deeply into fundamental analysis. We’ll explore in detail how to read financial statements, which financial indicators are important for valuing a stock, and how to consider the economic and industry context.

Therefore, if you’re interested in understanding how to assess a company’s true earning power and long-term prospects before investing, we invite you to follow our next in-depth discussions.