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Knowledge Choices for Investment - Technical vs. Fundamental Analysis: Which is Better?

written by: Zaid Aysen•edited by: Rebecca Scudder•updated: 10/15/2009

Trends and behaviour of financial markets are often realized in terms of fundamental as well as technical analysis. These two analysis tools hold extreme importance when the talk is of stock markets.

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    ‘Technical and Fundamental Analysis’ are two functional terms used to analyze the trends in the behaviour of the business markets in general and financial markets in particular. We would, for the purpose of this article, unless stated otherwise, be using the terms with reference to the Stock markets and shares. In a technical analysis, by using the variations in the past price, an analytical exercise is carried out to forecast the future price with reference to specific time- frame work. The inputs for such an analysis are the historical trends in price, the volume of an individual stock a sector (say Banking sector stocks) and/or the market as a whole.

    Fundamental analysis concerns itself to the methods of valuation of a chosen stock which entails analyzing its financials and operations with regard to sales, earnings, its potential for growth within the industry and in relation to the economy, assets and liabilities, including the current and fixed ones, method of capital deployed. In short, 'Technical Analysis' focuses on macro factors while the fundamental analysis restricts itself with the micro factors relevant to the chosen stock in question. An example of fundamental analysis is comparing and contrasting the political and economic factors between two countries and make an investment. This is highly relevant for the institutional sectors and sovereign wealth funds which would have to take into account the long term view of the country in its decision for investment. Once a choice is made, then a fundamental analysis of the stocks is made to effect investments.

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    Which One is Better?

    The reply has to be contextual rather than theoretical. The attitudes and motives of the investors are as diverse as the dispositions human beings possess and the take is individualistic rather than generalist. If you belong to the genre who believes in the long term and willing to trade off the present for the future,, the ideal choice for you would be to deploy fundamental analytical techniques to look for value and choose such stocks. Such investors tend to fish out under-valued companies on the belief that 'it's hard to fall out of a ditch'. They never look at the short term movement of the market and such news items as sensex takes dive on dim global cues, not holding the gains due to profit taking or 'flattens' as they do not cut ice with them. They believe in the maxim ‘in the short run, the market is a voting machine and not a weighing machine' which applies in mutalis- mutandis.

    On the other hand, investors, especially investing in the institutional and mutual funds, start from the top, scan the macro economic environment across the globe, then the regions, afterwards the sectors from where to individual companies and choose and pick from them.

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    Conclusion: Which One to Choose?

    Technical analysis bases its assumptions on (a) the market is aware of all the happenings, (b) prices are dependent on trends, (c) history repeats itself and (d) market is not only the mirror of the state of economy but also know in advance what is to come. Since the analysis has to give a shape to these assumptions and use sophisticated techniques, this is by and large not suited for retail investors. It is easier for them to grasp simple factors on the performance of a company in which they would like to invest based on reading of articles in the business section of newspapers, the magazines and within this if they would like to specialize they can go in for financial and economic dailies and magazines.

    For institutional and fund managers, they have to have a mix of both short term gains or minimising losses, and long term growth keeping in mind various factors which are beyond the influence of individual companies and the overall conditions of their own liquidity. They can employ research professionals who would bring in their expertise for making the choices. .Technical analysis would govern their choices but it is not as if they totally ignore fundamental analysis. Ultimately, investments are either bundled as packages or distributed individually and it is the need rather than the concept that would influence a decision.