As explained above, Technical Analysis deals with the study of historical patterns in price and volume data. On the other hand, Fundamental Analysis requires examining various characteristics (fundamentals) of a company and determining what should be the price of its share. Once the price is determined, we can use this derived price to compare it with the current market price. If the price determined through fundamental analysis is lower than the current market price, then stock is currently overvalued and price is supposed to come back to the fundamental price in long term. Thus, we should sell the stock. On the other hand, we will buy a stock when the price determined through fundamental analysis is more than the current market price, as we expect the price to move towards fundamental value in the long term. Let’s take an example to make this difference between fundamental and technical analysis clear.
Suppose you want to buy Bluetooth speakers. There are many brands available in the market and you are not sure which one to pick. In this scenario, you have following two options:
Visit the showrooms of all brands, try out different variants, do the bargaining and finally buy the product when you are satisfied.
Go to any online shopping portal (market) and check out which model has received highest rating. Online portals have this option where users can rate the model, based on their personal experience after buying. In this process, you don’t need to go to each showroom to bargain and try different variants. All the hard work is already done and you just need to buy the product with highest rating, believing that users who have rated the product have already done all the analysis and are happy with their purchase. In this option, chances of you getting a good deal on Bluetooth speakers are very high.
Option 1 is similar to Fundamental analysis where you research few companies thoroughly before making your decision. The advantage is that it will help you understand business of the company where you are putting your hard earned money and you will be more confident about your investment. At the same time, the problem with this technique is that you can only research few of the companies and there is a high probability that you might miss some of the best trading opportunities.
Option 2 is very similar to Technical Analysis where you look for patterns and preferences in the market. The biggest advantage of this method is its scalability. You can quickly and easily apply this method on various stocks and asset classes to pick your investment. However, following the herd may not be a good strategy always 🙂