Fundamental versus Technical Analysis

A difference of opinion is what makes a market. Someone feels that a security should be bought, someone else thinks that the security should be sold. They agree upon a price (the market price) and the transaction is completed.

Two major theories of market analysis are Fundamental Analysis and Technical Analysis. The difference between these two investment theories drive trades that happen in the market.

Fundamental Analysis is the process of evaluating a security’s intrinsic value (What is this company worth?). This is done by looking at all of the factors that affect the security. Analysts look at the current economic conditions, specific industry conditions, all the way down to judging the company’s management team. The idea is to compare this intrinsic value to the current price of the security to determine if a company is undervalued (meaning the price of the security would tend to rise) or overvalued (meaning the price of the security would tend to fall). The result of this analysis would tell the analyst whether the security should be bought or sold.

Technical Analysis is the analysis of statistical trends to determine the future price movement of a security. Technical Analysts look at price movement and trading volume to decipher patterns that would signal whether to buy or sell a security. The thought is that any security subject to supply and demand will follow certain chart patterns. If you can determine where a security is in the pattern, you can determine it’s future price movement.

In my mind, Technical Analysis is what drives short-term trading. Market traders using Technical Analysis can generate a lot of buy and sell signals that they use to get into and out of securities. Fundamental Analysis feels like a longer term trading strategy. News on a security will change the intrinsic value calculations of a Fundamental Analyst, but significant news is normally few and far between (quarterly earnings reports do happen each quarter).

Regardless of your investment strategy, understanding these two different investment theories can help to explain why individual securities trade the way that they do each day.

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