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Best Investment Approach: Technical Analysis vs. Fundamental Analysis

By  +Follow January 15, 2014 9:00AM
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It's a jungle out there for the retail investor and getting solid advice is difficult. The underlying problem is that one thing is generally true about anyone writing about the stock market or offering up professional investment advice: if these people really had all the answers, they would be extremely wealthy and most likely not working as financial writers or investment advisers.

However, that doesn't make it any easier to wade through the ocean of different advice and strategies that are out there. Just because a strategy works in one case doesn't mean it will work in another, and someone can give a series of solid pointers on stocks or strategies before being incredibly wrong when it counts.

Legendary stock-picker Peter Lynch may have put it best: "In this business if you're good, you're right six times out of 10. You're never going to be right nine times out of 10."

However, because one still needs to figure out some sort of investment strategy, here's a look at two major investment approaches to evaluating potential strategies that often times conflict with each other and both still have a number of adherents despite the conflict.

Technical Analysis vs. Fundamental Analysis

Fundamental analysis is pretty, well, fundamental. At its core is the belief in researching the specific nature of the business being invested in and focusing on this as a means for deciding on investments. The aforementioned Peter Lynch insisted that one should invest in what they know, buying stock in companies that make products familiar to the investor and that demonstrate a clear value.

Fundamental investors will focus on market trends, the underlying economy, a comany's balance sheet and management, all the specific data about what a company is, what it does, and how it's doing it.

Technical analysis comes from an entirely different school. A pure technical analyst operates in a relative vacuum, ignoring what a company is and does and focusing entirely on the information about how the company's stock has performed over time. At its core, technical analysis is based on the idea that the equities market is its own economy and the millions of investors out there will act in certain predictable ways.

People will tend to sell stocks they see as reaching their peak and buy stocks perceived as bottoming out almost regardless of what company that is. Through a focus on trends in the market and mathematical analysis of calculations like moving averages, resistance and support levels, and the underlying patterns that emerge from these, a technical analyst attempts to predict fluctuations share prices and profit from them.

In the end, it's about people's behavior. People who are buying and selling stocks tend to do so in ways that develop certain somewhat predictable patterns. What's more, because those very same people have learned to recognize those patterns, they can start to become self-fulfilling. People know a downward wedge is a bullish pattern, making them bullish on the stock, making it more likely that the bullish pattern will result in an upswing in the end.

And the Winner is...

Neither. As is almost always the case when two schools of thought coexist in one space, both systems have benefits and blind spots.

A technical analyst might find the perfect stock ready to rebound in a sugar company that's right at its 52-week low, hitting resistance, and has moving averages that indicate its poised for a break-out, but it's not gonna mean diddly if the price of sugar collapses or a hurricane decimates the company's operations.

Meanwhile, a company might have a solid business model and a product that no one can do without, but if the share price has been driven up by rapid buying for the last few months an investment might still lose money when the market corrects itself regardless of the inherent value of the company.

The best strategy most likely involves some combination of both, looking at both how the market is treating a stock while also considering the fundamental value of the company beneath it all. There are plenty of examples of very wealthy people who made their money purely through fundamental or technical analysis, so ignoring one or the other is something an investor does to their own peril.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions.


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By  +Follow January 15, 2014 9:00AM
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