Making an informed decision about any type of investment requires a meticulous analysis of the benefits and risks associated with the investment. Usually, an investment whose benefits outweigh the risk is what investors want. When analyzing an investment option, the most common methods of analysis are fundamental analysis and technical analysis. Choosing between these two methods of analysis is a constant struggle for investors.
While some believe that fundamental analysis gives an in-depth analysis of an investment option, others believe that using technical analysis helps you arrive at a decision much quicker. Each of these methods has its own merits and comes in handy based on your goals as an investor or how much risk you are willing to take. However, when both are combined they yield the best results, both in the stock market and crypto space.
As an investor, you want to make informed decisions about when to buy, hold or sell an asset. Therefore, this article will highlight the merits of fundamental and technical analyses and help you make the right choice whether you are investing in stocks or cryptocurrencies.
Source: Corporate Finance Institute
Fundamental analysis is a method of evaluating a company and determining the intrinsic value of its assets based on economic and financial factors. Data under review include the company's balance sheets, the management team, intellectual property, and products. These data form the metrics and ratios used to calculate the company’s performance, health, and growth rates.
During a fundamental analysis, the company is valued as unlisted with no regard for the current market price. This analysis aims to determine whether a company is undervalued or overvalued.
The technical analysis derives the value of an asset, based on price and volume data generated from the market. Technical analysis is not concerned with the effects of economics on the value of a company. Technical analysts base their decision on share price action and its performance in the past. They use historical trends to predict future price movements. By studying how investors reacted to a particular asset in the past, they can predict future performance.
Technical indicators form the basis of technical analysis. These indicators are used to study the historical data of an asset to determine favourable entry and exit points. By studying chart patterns and other market movements, technical analysts can identify trading opportunities likely to produce positive results. Technical indicators include the following:
Source: wisdom jobs.com
a. Trend indicators: also known as oscillators show the overall direction of the market. That is the wavy pattern that shows high and low values on the graphs. For instance, the Moving Average Convergence Divergence or MACD.
b. Momentum indicators are used to indicate the strength of a trend. They determine when a trend is about to reverse, that is it helps to predict when the price trajectory of an asset is about to change. Examples are the Average Directional Index or ADX, Relative Strength Index or RSI.
c. Volume indicators are used to determine the intensity of buying or selling market orders of a specific asset. For example, an on-balance volume or OBV indicator.
d. Volatility indicators determine how frequently the price of an asset is changing within a given period. The faster the price changes, the more volatile it is.
Fundamental or Technical: Which is Better?
As already mentioned, deciding whether to use technical or fundamental analysis depends on your goals and how much risk you are willing to take. While fundamental analysis is most useful for long-term investments, technical analysis is more useful for short-term trading and market timing. However, both can be combined to achieve desired results over medium and long term investments.
Choosing Fundamental Analysis
A major assumption of fundamental analysis is that the price of an asset in the market does not reflect the real value of a company. Fundamental analysis tends to predict an asset’s price movements by analyzing various economic, industry, and company data irrespective of the current market value. It aims to determine the quality of a long-term investment.
Fundamental analysis is your best bet if you are a beginner investor, long-term investor or you’re averse to high risk. This type of analysis encourages you to do your own research (DYOR). Therefore, with a deep understanding of the financial statements of a company, it becomes easier to determine if an investment opportunity will yield a strong return on investment or not.
Choosing Technical Analysis
Technical analysis shows you the direction of the market. If you are a professional investor with the ability to read charts and quickly identify signals that tell you when to buy and sell. Then the technical analysis is for you.
Also, note that an investor who makes a decision based on technical analysis is a huge risk-taker. This is because there is no 100% correct formula to predict market activities successfully. Be prepared to encounter a few losses. However, technical analysis provides you with more concrete data to make a decision based on current market activities.
Fundamental and technical analysis are both useful and effective approaches for making investment decisions. So long as you achieve your desired result, you can use either of the two methods of analysis.
For long-term investors, the fundamental analysis gives you an idea of a company’s value. This information comes in handy when picking stocks to hold for the long term and helps you manage risk. However, investment decisions based on technical analysis should be left to professionals with in-depth experience.
Choosing one method over the other is not a question of which is better but should be a decision you make based on experience level, goals, and your risk threshold as an investor. If you are new to investing in the stock market or crypto space, take your time to research and test the waters first with virtual money.