Market Analysis - The Merits Of Technical VS Fundamental Analysis
Market Analysis encompasses different tools and models to give investors and traders the best edge.
The 2 main tools employed are Technical Analysis and Fundamental Analysis.
It will be worthwhile to point out some of the main differences between Fundamental Analysis and Technical Analysis.
| Fundamental Analysis focuses on |
1. Macro Economic Factors
- Supply and Demand
- Other Market Data
2. Company Specific Data
- Valuations including Ratios of Price/Earnings(P/E), Price/Sales, Price/Book, PEG Ratio
- Profitability: Gross Profit Margin, Operating Margin, Net Profit Margin
- Growth Rates: EPS and Revenue
- Financial Strength: Total Debt/Total Capital, Quick Ratio
- Effectiveness: Return on Equity, Return On Assets, Return On Investment
| Technical Analysis focuses on |
- Price action
- Chart patterns
- Volume and Open Interest
- Traders/Investors Psychology
Fundamental Analysis VS Technical Analysis merits can be judged by the market activities of the last decade.
Can we survive another decade like the one between 2000 and 2010? It was the worse for investors since the Great Depression of the 1930s.
The Dow Jones Industrial Average started the decade of year 2000 at 10, 937.74.
It saw a high of 14,198.10. It crashed to a low of 6,469.95 on March 2, 2009.
It partially recovered from its low and ended the decade at 10,572.02. What a ride! Many people who panicked and got out at the bottom suffered huge losses.
Similarly, the S&P 500 Index started the decade at 1,394.46 saw a high of 1,576.09 and ended the decade at 1,136.52.
The NASDAQ Composite Index fared no better. It started the decade at 3,961.07, saw a high of 4,696.69 and ended the decade at 2,308.71.
Which Market Analysis strategy fared better? Was it Technical or Fundamental Analysis?
Those whose market analysis was based only on Fundamental Analysis were hurt miserably.
Investors who depended on Fundamental Analysis were buying and holding securities over that period. They saw their portfolios shrink.
Even worse were those who panicked and got out when the market bottomed in early 2009.They turned huge paper losses into actual loses before the market recovered partially from the bottom.
The rebound off the bottom is actually astounding - over 60% in many cases as of this writing.
For younger investors, as painful as this was, they have time on their side to play catch up.
However, older investors, especially those nearing retirement saw their 401Ks and other retirement vehicles crash and badly damaged. In many cases even their retirement income was put in jeopardy.
Which Market Analysis strategy was the better tool to weather the financial storm? Was it Fundamental Analysis or was it Technical Analysis? Was there a way to sidestep this market collapse, especially in the final years of the decade? Actually, yes there was!
Proponents of Technical Analysis ride the Trend whether the Trend is going up or down and get in or get out at Support or Resistance.
Technicians following the trend would actually have made money going down and on the way back up.
Fundamental Analysis Merits And Flaws
Fundamental Analysis is very important in predicting the long term direction of a stock. However, it has a serious flaw. It works with a lag.
It is also difficult, even impossible perhaps, to tell when it will be driven by it’s fundamentals.
The eminent Economist John Maynard Keynes put it best when he said that markets can remain irrational far longer than people can stay solvent.
But make no mistake, however, Fundamental Analysis is a powerful Market Analysis instrument over the long term. Stock prices will catch up to their fundamentals eventually, be they good or bad.
Technical Analysis Merits And Flaws
Technical Analysis on the other hand offers an immediate clue as to a stock’s direction which is signaled by the behavior of the stock price.
Technicians also believe that all the fundamentals of the stock are baked into the price anyway and just studying the price pattern will also justify the fundamentals.
Although there might be some credence to that as well as some arguments against, what is even more important is the fact that Technical Analysis has so many followers and users.
They all are observing the same Trends, Support and Resistance and they behave the same way based on the same observations.
The rationale that makes Trends, Support and Resistance ultra important to technicians is not really a mystery.
They are self fulfilling occurrences, particularly Support and Resistance Levels, especially when they occur at nice round numbers.
This is because many traders do the same things at the same time resulting in a herd mentality thus confirming these Support and Resistance Levels. So if you can identify these points, you can benefit immensely.
Hence the reasons for big bounces off Support and Resistance. To get a step ahead, many professionals try to preempt some of these events.
However, Technical Analysis does also have it’s flaws. It can give indication of moving in one direction only to sharply reverse and bolt in the opposite direction.
Traders caught in these Bull or Bear Traps have to scuttle to unwind their position or face serious and undesirable consequences.
Which Market Analysis strategy is best? In the long term they both have strong merits. For those in a hurry, Technical Analysis wins handily.
Continue here to Find Potential Trade Opportunities Using Simple Technical Analysis.
It doesn’t matter whether the market is moving up or down.
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