Difference Between Fundamental and Technical Analysis

Key Highlights:

• Fundamental analysis involves analysing a company’s fundamentals.

• Technical analysis entails the analysis of technical charts and tools to find out a stock’s future price movement.

• While fundamental analysis considers present and past data, technical analysis considers only historical data.

• Fundamental analysis factors in various macroeconomic factors, while technical analysis involves volume trend analysis.

As an investor, it’s essential to thoroughly analyse stocks before investing. Prudent analysis helps you make the right choice, which goes a long way towards wealth creation. Understanding the difference between fundamental analysis and technical analysis is key, as both offer unique ways to evaluate a stock’s potential.

What Is Fundamental Analysis?

Fundamental analysis evaluates the true worth of a stock or security by studying its underlying business and economic factors. Instead of focusing on price charts, it examines a company’s financial health, management efficiency, industry position, and overall economic environment. The goal is to determine whether a stock is undervalued, fairly priced, or overvalued in the market.

The process of fundamental analysis involves the following steps:

• Economic Analysis: It begins with examining the broader economic environment, such as GDP growth, inflation, interest rates, and government policies, all of which directly affect businesses.

• Industry Analysis: Next, the industry in which the company operates is studied. Factors such as demand trends, competition, regulatory policies, and growth prospects are considered.

• Company Analysis: Finally, the company itself is evaluated by examining its financial statements. Key ratios such as earnings per share (EPS), price-to-earnings (P/E) ratio, return on equity (ROE), and debt-to-equity ratio are analysed. Non-financial aspects such as management quality, corporate governance, and market reputation are also reviewed.

Fundamental analysis helps you conclude whether a stock is trading above or below its ‘intrinsic value’ (the actual worth determined from analysis). If the intrinsic value is higher than the market price, the stock is considered undervalued, signalling a good buying opportunity. Conversely, if the intrinsic value is lower than the market price, the stock is considered overvalued, suggesting it may be better to avoid or sell.

Shortcomings of Fundamental Analysis

Fundamental analysis has the following drawbacks:

• Many aspects of fundamental analysis depend on assumptions such as growth projections, discount rates, or future earnings. These assumptions may not reflect reality. If the inputs are inaccurate, the valuation model can produce misleading results.

• Even detailed analysis cannot fully predict short-term price movements. External factors like investor sentiment, geopolitical risks, or sudden regulations can drastically impact prices. Since fundamental analysis mainly focuses on long-term prospects, it is less reliable for those seeking accurate short-term predictions.

• While fundamental analysis studies intrinsic value, it does not account for behavioural elements such as herd mentality, speculation, or panic selling. Market sentiment often drives stock prices beyond rational valuations. As a result, a fundamentally strong company may underperform simply due to prevailing negative market sentiment.

• Most financial metrics in fundamental analysis are based on past performance. Although history provides useful insights, it does not guarantee future success. Industries disrupted by technology, regulatory changes, or unexpected crises may no longer follow past patterns, making analysis less reliable in dynamic or evolving sectors.

• Fundamental analysis is often industry-specific. Comparing two companies from different sectors using the same metrics can be misleading because profitability, valuation multiples, and growth drivers vary widely. This makes it difficult for investors with diversified portfolios to apply uniform yardsticks across industries.

• Valuation methods such as Discounted Cash Flow are highly sensitive to small changes in inputs. Even a slight change in growth rate or discount factor can drastically alter the outcome of a valuation.

• A company’s performance depends heavily on its leadership. However, evaluating management’s integrity, decision-making ability, and long-term vision is subjective. Public reports or interviews may not reveal the complete picture.

What Is Technical Analysis?

Traders and investors use technical analysis to assess securities by studying historical price data and trading volumes. Unlike fundamental analysis, which focuses on factors such as revenue, profit, or balance sheets, technical analysis assumes that all known information is already reflected in the market price. The primary belief is that price movements follow patterns that tend to repeat due to market psychology and behaviour.

• The process begins with gathering historical market data, including price charts and volume records.

• Analysts then apply tools such as trend lines, moving averages, oscillators, and candlestick patterns to identify trends and potential reversals.

• Chart patterns such as triangles, head and shoulders, or double bottoms are examined to predict future price directions.

• Indicators such as the Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), and Bollinger Bands help assess momentum, overbought or oversold conditions, and volatility.

• Technical analysis can be applied across multiple timeframes, from minutes to months, depending on whether one is a day trader, swing trader, or long-term investor.

From this process, traders infer possible entry and exit points, stop-loss levels, and target prices. For instance, if a stock breaks above a resistance level with high trading volume, it may signal a buying opportunity. Conversely, if it falls below a support level, it might indicate further downside. While technical analysis does not guarantee accuracy, it helps increase the probability of making profitable trades by recognising patterns and market sentiment.

Shortcomings of Technical Analysis

Technical analysis comes with the following drawbacks:

• Technical analysis ignores core fundamentals like company earnings, management quality, or economic growth. These factors often drive long-term value but are excluded in chart-based analysis.

• Charts and indicators can be interpreted differently by traders. For example, one analyst may identify a “head and shoulders” pattern, while another may not consider it valid. This subjectivity reduces consistency in decision-making.

• In times of global crises, elections, or sudden economic data releases, technical indicators often fail. Price movements can become erratic, rendering traditional support or resistance levels irrelevant.

• Most technical indicators, such as moving averages, are lagging tools. They confirm trends only after prices have already moved significantly, often causing traders to enter late or exit after most profits are gone.

• Analysts may identify patterns in charts that appear meaningful but have no real predictive value. This phenomenon, known as overfitting, occurs when traders impose patterns on random price movements.

• Coordinated trades, false rumours, or sudden price pumps can influence markets. Technical analysis does not account for such external distortions.

• Technical analysis does not incorporate macroeconomic influences such as inflation, interest rate changes, or geopolitical tensions. These factors significantly affect market sentiment and long-term price movements.

Fundamental Vs Technical Analysis: The Differences

The table captures the key differences between fundamental analysis and technical analysis across various parameters:

Fundamental and Technical Analysis: What Should You Choose?

When it comes to fundamental analysis vs technical analysis, both approaches have their own benefits and drawbacks. While the former helps you identify stocks that could be multibaggers in the future, the latter helps you gauge a stock’s future price movement and the right time to buy or sell a stock. Through fundamental analysis, you can find out about companies with high growth potential, while technical analysis tells you when you should invest in them.

In conclusion

Both technical and fundamental analysis are essential in their own way in stock investment. Combine both to achieve the best results and get going. Happy investing!