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Technical analysts do not attempt to measure a security's intrinsic value. Instead, they use stock charts to identify patterns and trends that suggest what a stock will do in the future. Fundamental analysis and technical analysis are the major schools of thought when it comes to approaching the markets. Simple Moving Averages Simple moving averages are indicators that help assess the stock's trend by averaging the daily price over a fixed time period. Buy and sell signals are generated when a shorter duration moving average crosses a longer duration one.
Support and resistance utilize price history. Support is defined as areas where buyers have stepped in before, while resistance are areas where sellers have impeded price advance. Practitioners look to buy at support and sell at resistance. Trend lines are similar to support and resistance, as they provide defined entry and exit points.
However, they differ in that they are projections based on how the stock has traded in the past. They are often utilized for stocks moving to new highs or new lows where there is no price history. Each of these have unique formulas and provide buy and sell signals based on varying criteria.
Momentum indicators tend to be used in range-bound or trendless markets. Key Takeaways Fundamental analysis evaluates securities by attempting to measure their intrinsic value. The idea is to have more or bigger gains than failures, and on average, make money.
Unfortunately, many people choose poor timeframes or allow emotions to rule their trading. This negatively impacts profits and losses. Furthermore, technical analysis solely focuses on price action. There is little in the way of news, management, or product analysis. As mentioned, Big Data and AI might somehow quantify news and customer perception, but for the average individual trader, these are out of reach. This means TA is decoupled from the underlying asset in a way. For those who invest because they believe in a product or company, TA may even seem soulless.
Moreover, decoupling from the asset can be dangerous. News, upcoming earnings, and other fundamentals that hold considerable influence cannot be ignored. Few people engage solely in charting and TA. Fundamental Analysis While TA is concerned singly with price action, fundamental analysis takes into account many other factors.
There are certainly quantitative ratios, especially regarding the financial health of a company, and they are absolutely important to FA. However, FA tends to incorporate other factors as well and focuses far less on the observable trends on a chart derived from the dataset of historical prices.
Furthermore, because FA ratios are slower moving once a quarter or year for many that require financial statements , FA tends to focus on the long term rather than the short term. Metrics and Financial Ratios Finance is inherently a quantitative field.
It is not advisable to entirely neglect financial ratios and metrics for any sort of investing. Money is really just numbers and perception, and finance is a numbers game. Hence, there are plenty of ratios and indicators that fundamental analysts use to gauge the investment-worthiness of an asset. Reading the financial statements is an integral part of FA, and gauging those ratios is certainly a core task for any fundamental analyst. While TA requires no accounting knowledge, FA requires quite a bit.
Earnings ratios: these give an idea of how much profit the company generates compared to some important factors. Large companies tend to be more resistant to price swings due to daily trading, since it takes more money to affect the whole market.
Bad news, of course, will drop a stock regardless of market cap. Debt and Equity Ratios: These measure how much a company owes to debtors and how much investors have in the company. There are plenty of ratios, but usually lower debt and higher equity numbers are preferable. Of course, one must compare these to the industry, as some industries may routinely carry significant debt.
If the interest coverage ratio is also low, the problem is compounded. On the other hand, if the company has an envious interest rate, there may be a low current ratio but high interest coverage ratio. Cash Flow Ratios: Cash flows are indicative of solvency, profitability, and managerial skills. Poor performance here indicates precarious debt situations or poor management. Inventory Ratios: For retailers and other businesses holding large amounts of inventory, these ratios cannot be ignored.
A high inventory turnover rate demonstrates a company can effectively manage its inventory levels and is actually able to sell what it purchases. Qualitative Considerations I will write it again: finance is a numbers game, and FA certainly acknowledges that. However, some other, non-quantitative factors influence FA decisions.
These probably could be quantified to an extent, but many people do not attempt it. Management A major influence on the decision to buy or sell a company for fundamentalists is who is part of management. A serial entrepreneur on the Board could bode well for the company. An uncommunicative management is anathema to fundamentalists. While many companies exist to make money and fulfill some sort of need for society, others may be viewed by the general public in a negative light.
For some investors, this can be a dealbreaker. Regarding perception, a stellar marketing campaign can differentiate the thriving from the dying. An investor who expects an upcoming marketing campaign to be groundbreaking or to immediately go viral may invest, even with poor financial ratios. Belief in the Product One final reason people may invest is a deep belief in a product or service.
Angel investors, late-stage investors who often save companies from bankruptcy, certainly expect to make a tidy profit from a struggling company. This belief often stems from a belief in the product to be useful and valuable to society and mankind. For many employing FA, though, the reply may be a substantial speech about the merits and benefits of the companies they choose. Some people simply enjoy the thought that their investment contributes positively to the world.
It is a very brief overview of the approaches to the market. The most important differences — timeframes, focus charts VS financial statements , and some personal philosophies make money or support a company — are only slightly described above.
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Fundamental Analysis vs Technical Analysis
