Fundamental Analysis vs. Technical Analysis: What’s the Difference and How to Use Them Both?

Most people are familiar with two major approaches to evaluating investment opportunities: fundamental analysis and technical analysis.

However, not many people know exactly what they are. If you’re new to investing and don’t have a strategy, you should definitely read on.

In this article, I’ll break down these two approaches in simple terms, highlight their differences, and explain how you can use them to make more informed (and hopefully more profitable) investment decisions.

What is Fundamental Analysis?

Fundamental analysis is seen as a serious approach, associated with old-school traders. But it’s actually based on a very simple premise and focuses on long-term returns.

This strategy requires you to act like Sherlock Holmes, examining all the clues, researching financial statements, industry trends and economic indicators to deduce the intrinsic value of a security.

It is preferable to be obsessed with numbers and have a creepy fascination with reading financial statements.

Here are some of the tools these financial sleuths use:

• Price-to-earnings (P/E) ratio: Think of it as the “is this stock too expensive?” ratio. It compares a company’s stock price to its earnings per share. A low P/E ratio can mean a good bargain, but it can also mean something is fishy, like a suspiciously cheap sushi place.
• Earnings per share (EPS): This is the part where you see how much money the company makes for each share you own. Higher EPS usually means the company is more profitable, which is always a good thing.
• PEG Ratio: This clever little ratio compares the P/E ratio to the company’s growth rate.
• Book Value: This measures what the company would be worth if it were liquidated today. You can think of it as the yard sale value of the company.
• Return on equity (ROE): This ratio calculates a company’s net income as a percentage of its equity. It is like a benchmark on how effectively the company is using investors’ money to make a profit.

What is technical analysis?

Technical analysis, on the other hand, relies more on charting and pattern recognition.

Instead of focusing on the intrinsic value of securities, technical analysts (or chartists, if you want to look fancy) try to predict future price movements based on historical price and volume data.

They are the ones who look at candlesticks and Fibonacci retracements, searching for patterns as if they were trying to decipher ancient financial hieroglyphics.

I’m talking about the language you don’t understand when your chart watching friends talk, if you know what I mean.

Here are some of the favorite toys in a technical analyst’s toolbox:

• Trend lines and patterns: These can be described as mood swings in the financial market. Analysts use trend lines, continuation patterns, and reversal patterns to predict where the market might go next. In other words, they find a range where the price is fluctuating and profit from it in the short term.
• Relative Strength Index (RSI): This measures the speed and variation of price movements. It’s like a lie detector test for stocks and may indicate overbought or oversold situations. By looking at this, you are trying to predict whether the price will go up or down.
• Volume indicators: These track trading volume to measure the strength of price movements. Sometimes it’s not the size of the price change that matters, but the volume of trading behind it.

Key Differences Between Fundamental and Technical Analysis

Which method of analysis is right for you?

The choice between these two methods depends on your investment objectives, risk tolerance, and time horizon. Here’s a quick guide to help you decide:

• Long-term investors: If you’re looking for steady, long-term growth and don’t mind waiting a while to see a return on your investments, fundamental analysis is your friend. Plant a tree and wait; after 15–20 years, you will have a tree that will consistently give you fruit.
• Short-term investors: If you’re looking for quick profits and enjoy the adrenaline rush of watching stock prices fluctuate, technical analysis is for you. It’s more like surfing the waves of the market. So, there is always the possibility of drowning.

Using Both Methods

In my opinion, if you want to be successful, you don’t have to choose, you have to use both.

Long-term low-risk profits or short-term high-risk profits seem like a choice here, but it’s not necessary.

So, here’s my advice: Be a long-term investor who sets medium-term goals.

Let me explain;

Let’s say you find a stock that is significantly undervalued based on fundamental analysis. Instead of buying it and holding it for 10 years, put it through technical analysis.

Look at the charts and set medium-term price targets for the stock, and when the stock reaches a satisfactory price target, sell 3/4 of it and move on to another investment opportunity.

You can hold the rest for the long term. By selling in this way, you can avoid price declines over a period of, say, 10 years.

How does this work?

Imagine that the price of a stock goes from $10 to $50 in 10 years. It won’t be a continuous rise, because there will be at least a few significant pullbacks in between.

But you can avoid those pullbacks by selling the stock before they happen. Let’s do a little math to make this clearer.

Let’s say you made an investment of $1000 by buying 100 shares at $10 each. After 10 years, when the stock is 50 dollars, your investment will be 5000 dollars, so you will make a profit of 4000 dollars. It’s very simple.

In my strategy, based on technical analysis, we predict that the price will experience selling pressure at $20, $30 and $40 (for easy calculation).

When the price reaches $20, we sell 3 out of 4, i.e. $1500, leaving $500 invested. Then (the time interval is uncertain) the price falls and we buy the stock again at $15 with the $1500 we sold. In this way, we have bought 100 shares and have a total of 125 shares.

We do this for other price levels as well. Since you understand the logic, I will go straight to the result without doing all the calculations.

If you continue to trade in this way, at the end of 10 years you can have about 225 shares in your hands. This is an asset of 11250 dollars at a price of 50 dollars.

In other words, with this method it is possible to make a profit of more than 10000 dollars instead of 4000 dollars.

However, keep in mind that in order to be successful with this method, you need to be able to do both types of analysis.

The best approach, in my opinion, is to use the most useful aspects of both types of analysis to formulate a strategy, and the direction in which that strategy is weighted depends on how effectively you use them.

I hope this article has been an effective guide for your investment strategy. Have a good day…