Fundamental vs Technical Analysis
July 2022
In the world of the stock market, there are two major investment approaches with fundamentally different methodologies for evaluating and predicting financial market behavior—often without consensus between them. I am referring to fundamental analysis and technical analysis.
Fundamental analysis focuses on studying economic, financial, and business factors that influence the value of companies and markets. In contrast, technical analysis is based on price movements and graphical patterns in market charts.
Fundamental analysts examine a company's financial health, market position, competition, revenues, expenses, debt levels, dividends, and growth potential. They also consider macroeconomic factors such as inflation, interest rates, and government policy changes that could impact the market. On the other hand, technical analysts believe that all relevant information about a company or market is already reflected in its price and chart patterns.
The core idea behind fundamental analysis is based on determining the intrinsic value of a company, regardless of market fluctuations. It involves purchasing an asset for less than its true worth, based on a comprehensive evaluation of the business, including revenue trends, profit margins, and financial statements such as cash flow, balance sheet, and income statement. Conversely, technical analysis disregards the business fundamentals and instead relies on chart patterns and market psychology, making it an approach that exists solely within financial markets. Additionally, there are no highly successful investors who have relied exclusively on technical analysis.
Both approaches have their supporters and critics, and investors typically adopt one or the other. While legendary investors such as Warren Buffett, Peter Lynch, and Charlie Munger adhere to fundamental analysis, technical analysis also has its advocates.
Fundamental analysis
Key Principles of Fundamental Investing:
What matters is the business and evolution of sales and margins .
Analyze the financial statements , income statement, balance sheet, cash flow.
Based on buying something for less than it is worth .
It applies to any field of investment .
Big investors use it - Warren Buffett, Peter Lynch, Charlie Munger, etc.
The main characteristics of fundamental analysis consist of paying full attention to the company's financial statements , specifically the evolution of sales, operating margins, net profit, earnings per share (EPS) growth, free cash flow FCF, the company's debt level, etc. to form an idea of how the company's growth will be in the following years and try to predict future earnings per share, in addition to calculating the intrinsic value of the company, to determine if we are buying something at a fair price, or if possible, for less than it is worth.
Qualitative analysis also plays a very important role in fundamental analysis . Determining why the company will do well in the coming years is vital. Knowing its competitive advantages, quality of management team, products, growth strategy, etc. is key to ensuring that we are buying a quality business.
Fundamental analysis is used for real estate investing in the same way as it is for investing in other assets . For real estate investing, fundamental analysis involves examining factors such as the property's location, trends in the area for growth and development, the market value of similar properties in the area, occupancy levels and vacancy rates, maintenance costs, and potential improvements that can be made to increase the property's value, among other factors.
Great investors such as Warren Buffett and Charlie Munger have used fundamental analysis as a key part of their investment strategy . In fact, you could say that fundamental analysis is the foundation of Buffett and Munger's investment strategy. Both investors have spoken about the importance of fundamental analysis in making investment decisions. Buffett, for example, has said that his approach is based on "buying great companies at reasonable prices" and that he uses fundamental analysis to evaluate the potential of the companies he is interested in. Munger, for his part, has spoken about the need to consider multiple factors in evaluating a company, including management quality, growth potential, financial strength, and competitive position in the market. In general, both investors use fundamental analysis to evaluate a company's intrinsic value and determine whether it is undervalued or overvalued in the market. By evaluating a company's fundamentals, they can make informed decisions about whether or not to invest in it. Warren Buffett's long-term investment strategy involves avoiding day trading and the temptation to buy and sell in short time frames .
Technical analysis
Key Principles of technical analysis:
It is based on graphics .
It is based on psychology .
It doesn't matter the business.
It only exists in the stock market .
There are no “existing” investors who have only used technical analysis.
Unlike fundamental analysis, which focuses on analyzing a company's financial condition and growth prospects, technical analysis does not take into account detailed financial information of the business , such as revenue, expenses, balance sheet, or cash flows. Instead, it focuses on the fluctuation in asset prices and uses technical tools, such as trend indicators, support and resistance analysis, and moving averages, to identify patterns and trends in the market. Some technical indicators are RSI, MACD, STO, etc. that measure possible price variations:
The RSI shows price strength by comparing individual upward and downward movements of successive closing prices. It ranges from 30 to 70, if it is above 70, it means the market is overbought and the price is likely to fall back. If it is below 30, the opposite is true.
The MACD or moving average is a technical indicator that measures the strength of price movement. If it crosses the signal line from the bottom, it can be interpreted as a buy signal, and if it crosses it from the top, it can be interpreted as a sell signal.
The STO or Slow Stochastic Oscillator is a momentum indicator that shows the location of the close relative to the high-low range over a given number of periods. The indicator can range from 0 to 100. The closing price tends to close near the high in an uptrend and near the low in a downtrend.
Other terms also used are supports, trend lines and candlestick charts to identify patterns and trends that may indicate changes in market direction.
Psychology plays an important role in technical analysis. Technical analysis is based on the study of chart patterns of asset prices, which are determined by market forces and the psychology of investors. One of the main psychological aspects that influence technical analysis is crowd behavior. Chart patterns in the market reflect the emotions and attitudes of investors and can therefore be used to predict the future direction of asset prices. For example, investor behavior can be reflected in patterns such as market tops and bottoms. Another important psychological aspect in technical analysis is loss aversion. Investors have a natural tendency to want to minimize their losses, which can lead to irrational decisions such as holding onto losing positions for too long. Finally, market psychology can also influence trend formation and volatility. Investors may have a tendency to follow the herd and enter and exit the market in groups, which can result in sharp movements in asset prices.
Technical analysis is difficult to replicate in other investment assets other than financial assets . In the case of real estate assets, for example, it is not possible to use price charts and patterns to make investment decisions. It is difficult to imagine a real estate investment study where head and shoulders candles, supports or resistances are used to determine the price of the property , it would be something really out of context. However, there are certain liquid financial assets that can be analyzed with technical analysis tools, such as the foreign exchange market (Forex) and financial futures. In these cases, investors can use technical tools, such as moving averages, oscillators and trend indicators, to analyze price patterns and make investment decisions.
Finally, it is important to note that there are no successful investors who have been successful over time using technical analysis alone. Although technical analysis can be useful in investing in liquid financial assets, it is not a complete tool on its own for making informed investment decisions.
"Price is what you pay, value is what you get."