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Fundamental vs technical analysis: which strategy should you use when investing?

As you make important decisions on which stocks or companies to invest your money on, you'll come across the choice of whether to use fundamental analysis or technical analysis in your investment evaluations.

No one can say for certain which technique is better, since they each have their own merits. But a good place to start would be to learn more about how both strategies work, as well as their pros and cons.

Fundamental analysis

Fundamental analysis is a method of evaluating all the components that make up a company or stock to determine its intrinsic value. This method will take into consideration the financial and management conditions of the company. This means a company's assets, liabilities and management will all be factored in with a fundamental analysis. In addition, you would also evaluate the overall condition of the wider economy.

Fundamental analysis assumes that a particular stock price will return to the right level in line with its fundamental conditions if it is currently over- or under-priced. This technique is most preferred by long-term investors.

Pros:

  1. Fundamental analysis is based on fundamental data that is quantitative in nature, so it mostly eliminates personal biases.

  2. Besides unearthing the financial numbers of a company, macroeconomic factors are also taken into consideration, giving you a comprehensive analysis to help make better decisions.

  3. You'll gain a good understanding of the industry of the company/stock you plan to invest in. For example, investors will conduct research on the telecommunication industry if they decide to invest in Singtel.

  4. As fundamental analysis is very comprehensive in nature, it may help potentially detect any red flags within a company's financial statements. These will come in handy in revealing or predicting any potential problems in the company and could save you from possible investment losses.

Cons:

  1. The biggest drawback of fundamental analysis is that it is time-consuming. Beyond analysing the stock prior to investing, you'd also need to monitor all of a company's financial data periodically. Additionally, you'll have to keep track of all other economic trends, and related industry events and situations, because any negative news could cause an unexpected decline in stock prices.

  2. To perform fundamental analysis well would require a good level of knowledge that will help with interpreting the data you've got at hand. Of course, this acumen can be improved with more practice over time.

  3. Herd mentality and human emotions are not taken into account, even though they are important factors impacting bull or bear runs in the market. This means if you invest in a fundamentally strong stock at the wrong time, you may have to hold on to it for a longer period in order to see returns.

Technical analysis

On the other hand, technical analysis is anchored in stock price charts and/or volume data, using previous price history to predict future price movements of a stock.

The core assumption of technical analysis is that all fundamental conditions are already factored into the price history. Technical analysts and traders will place more emphasis on knowing stock price movements in the next hour, day, or week. Mostly, short-term investors or who we typically term day traders rely on the technical analysis strategy more.

Pros:

  1. History tends to repeat itself and this applies to market cycles and movements too. Looking into patterns might just give you information on appropriate signals/breakout points to earn profit on your investment.

  2. Technical analysis usually requires much less data and research than fundamental analysis. Traders will typically be keen to use this method to trade in stocks (short term) rather than to invest for the long term.

  3. Technical analysis contains the element of human interpretation in the equation, which helps you see beyond the math to identify good investment opportunities. For instance, you may see a stock has been having a recent bear run, but since you've tracked its historical performance and expect a recovery to take place, you might decide to continue holding on to it.

Cons:

  1. Technical analysis involves using different patterns as indicators for your investment decisions. These indicators will help point you towards a buy or a sell decision, but any delay in response to analyse the historical performance of a stock sometimes puts you at a disadvantage in capturing the movement.

  2. Traders may sometimes use 2 different indicators as part of their investment strategy. The flip side of this is the indicators may derive contradictory results and create confusion instead. That's why it's important to consider other factors beyond the indicators before making a final decision.

  3. Technical analysis involves human interpretation, so it's subject to an individual's bias about a given stock and this could potentially affect investment and trading decisions.

Which strategy is the right fit for you?

Now that we've gone through some pros and cons of both fundamental and technical analysis, you should be better equipped to decide which strategy works better for your investment and trading needs and goals.

A good way to sum all this up is this: fundamental analysis tells us where to invest, while technical analysis indicates the best time to enter (or exit) the market. Supporters of both camps will have their fair share of proven results, but it's hard to say for sure which strategy is ultimately better. Depending on your investment goals and time horizon, the best idea would probably be to combine the 2 techniques and use them together to get the best of both worlds.

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