Investing in stocks is a great way to build wealth and save for retirement. Choosing which stocks to invest in can be a challenge. That’s why investors turn to strategies like fundamental and technical analysis to help them pick stocks to buy and sell. Here’s a breakdown of each approach so you can find the one that works best in any particular situation.
What Is Fundamental Analysis?
Fundamental analysis is built on the notion that at any given time a company’s shares have an intrinsic value, which the market will recognize, sooner or later. To discover that value, which is also called a share’s fair or enterprise value, primary attention is paid to a corporation’s financial performance. However, fundamental analysts also evaluate the state of that corporation’s industry and the health of the overall economy.
Corporate financial performance metrics of interest to fundamental analysts include the earning-per share (EPS), dividend yield, price-earnings (P/E) ratio and return on equity. It also focuses on a company’s assets, liabilities and expenses.
Fundamental analysis depends on close examination of corporate reports filed with the Securities and Exchange Commission, such as the 10-K and 10-Q, as well as sell-side analysts’ reports on the company.
What is Technical Analysis?
Technical analysis is built on the idea that share price movements often follow a pattern that can be discovered through analysis of a security’s prices and volume of shares traded. Those two metrics are assessed to find trends in the movement of a share’s price. For example, if the average price of a share over a short time period, for example 50 days, crosses above the moving average of a share price for a longer time period, for example 200 days, technical analysts might see a buy signal. Likewise, if a stock’s 50-day moving average price falls below its 200-day moving average, technical analysts might see a sell signal.
Volume is the other key metric in technical analysis. Above-average trading volume, for instance, could suggest an imminent price breakout, either up or down.
It’s important to note the focus is on the actual price of the stock, not the financial health of the company or industry or economy. When using technical analysis, you’re assuming all the relevant information is already in the pricing history.
Which One Should You Use?
For decades, the preferred and most credible method of evaluating stocks was fundamental analysis. As technology continues to advance and more information is widely available, this has been changing. This means that most investments first use black-box trading or computer modeling to determine the best investments. Most of the largest firms make investment selections based on computer algorithms that use a combination of technical and fundamental factors.
When it comes to investors like you, you may feel comfortable using a specific strategy. You may also choose to use a combination of a few. Both fundamental and technical analysis provide tools for helping you make the best buying decision. For example, let’s say you’re an investor who focuses on growth and are interested in how a security or company will perform over a long period time. Therefore, you may feel more comfortable using fundamental analysis.
In summary, technical analysis uses data from short periods to identify patterns and forecast performance. Since the data collection duration is a brief period, this method is often better suited for investors who are looking for a short-term investment decision. On the other hand, fundamental analysis is potentially a better fit for those evaluating long-term investment decisions. This is because fundamental analysis uses information that spans years, which may give more insight into investments that you may hold for a longer period.
The Bottom Line
Fundamental analysis uses a variety of quantifiable metrics to determine the quality of a long-term investment, while technical analysis uses share price trends and trading volumes to decide what you should invest in when you have a shorter time horizon. If a stock does well, based on the expectations set by your analysis, then you stand to gain. However, your results may largely depend on how well you research different stocks. It also depends on how well you read the signals they’re sending to the market.
Remember, the stock market can be unpredictable. Fundamental and technical analysis are just two tools you can use to navigate it.
Consider talking to a financial advisor about how fundamental and technical analysis could improve your investment decisions. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
Don’t assume that your investment strategy needs to depend exclusively on one kind of analysis. You may find that technical analysis works better in some situations while fundamental analysis works better in other situations.
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