Understanding the Two Main Schools of Investment Analytics

Buy low, sell high.” If only stock market investing were so simple. In reality, successfully deciding which stocks to buy and sell, and when to buy and sell them, is an extremely difficult thing to do on a consistent basis.

To help them make successful buy and sell decisions, serious investors use one of two different types of stock market analytics: fundamental analysis or technical analysis. These two methodologies are as different as night and day, and each has its diehard proponents and vocal critics.

Why They Are Different

As the name suggests, fundamental analysis looks at fundamental economic factors, like the broad economy, conditions within a particular industry, and a company’s financial condition, in analyzing a stock. Its goal is to determine the company’s intrinsic value so that an educated decision can be made about whether it is under- or over-valued and hence should be bought or sold.

Technical analysis uses charts and data to study the history of a stock’s price movements and volume. It looks for patterns and trends that offer clues as to which direction the stock’s price will move in the future. Unlike fundamental analysts, technical analysts do not consider intrinsic value when making buy and sell decisions — they are simply looking for patterns indicating future stock price movements.

While fundamental and technical analyses are polar opposites of each other, there are situations where they can both be used by an analyst at the same time. A fundamental analyst might use technical analysis to determine the best time to buy or sell a stock he believes to be undervalued. On the other hand, a technical analyst might look at a company’s fundamentals to help confirm a technical buy or sell signal.

For example, high price volatility is a key technical indicator of investment risk. It may also be a leading indicator of changes in a company’s core fundamentals. Therefore, different analysts using fundamental and technical analysis might arrive at the same decision with regard to whether it is time to buy or sell a stock.

More Fundamental vs. Technical Distinctions

Fundamental analysis is long-term in nature, while technical analysis is relatively short-term — as short as minutes for active traders trying to profit from minute-by-minute fluctuations in stock prices. Fundamental investing is also sometimes referred to as value investing: The analyst believes that a stock is underpriced or overpriced, based on what he believes its intrinsic value to be, and that over time the price will rise or fall to reflect its true value. Warren Buffett is probably the best-known proponent of value investing. This is why it is sometimes said that fundamental analysts are making investments, while technical analysts are making trades. The former invest in stocks that they believe will increase in value over time due to strong fundamentals, while the latter trade stocks which they believe they can sell quickly for a profit.

Another distinction is the different types of data that fundamental and technical analysts study. Fundamental analysts are mainly interested in a company’s financial statements — specifically the income statement, cash flow statement and balance sheet — as well as the 10Q and 10K statements issued by public companies. Being able to dig into these and uncover fundamental data like assets, liabilities, operating expenses and earnings per share is the key to enabling analysts to arrive at a company’s intrinsic value, and thus decide whether to buy or sell the stock and when to do so.

Conversely, technical analysts are mainly interested in studying a company’s charts. These charts help analysts to identify trends and patterns that they believe will indicate whether the stock will move up or down in the future. They believe that a company’s fundamentals are already reflected in its stock price, so there is no reason to study them further (except when they might look at fundamentals to confirm a technical signal, as described above).

Team Fundamental vs. Team Technical

Think of the debate between those in the fundamental analytics camp and those in the technical analytics camp as the investment version of Twilight’s “Team Edward vs. Team Jacob”. Fundamental analysts are sometimes highly critical of technical analysis, even calling it “investing voodoo” and mocking technical analysts. Most Wall Street investment analysts practice fundamental analysis, although most of the big brokerage firms feature technical analysts as well.

Meanwhile, many technical analysts believe that fundamental analysis may result in improper stock valuations. This is because fundamental analysis looks backward at what has already occurred, not forward at what is likely to occur in the future. They believe that their forecasts, based on the careful study of patterns and trends, paint a more accurate picture of a company’s future performance and stock price.

There is no definitive answer as to which type of investment analytics is right or wrong or whether one works better than the other does. You should do some more research and investigation into each before deciding which type is best suited to helping you meet your investing objectives.

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