The techniques for choosing shares broadly fall into two main categories: Fundamental Analysis and Technical Analysis. Often investors favor fundamental analysis to fill their portfolios with promising equity investments. On the other hand, traders often favor technical analysis to predict short term price movements. It is not uncommon for each camp to implement both types of analysis in some form or another.
Contrary to popular belief, traders often have an easier time picking short term direction than investors do with long term stock positions. It is therefore important traders apply sound technical principles in order to be successful.
Fundamental analysis is essentially number crunching. It involves using information gleaned from company results and announcements to make a call on whether the share price is poised for growth. Figures contained in these communications can be used to calculate ratios that indicate whether the stock is fairly valued, how much the company is returning to shareholders and the strength of its balance sheet. Other things to look at can include studying published information about the companies, industry sectors, and economies.
The building blocks of fundamental analysis include a company’s share price, its market capitalisation (size), its earnings, and dividends. There are many fundamental ratios used to help an analyst quickly scan through the market to find companies that look healthy. These ratios are generally built or obtained from information in company reports, which can most easily be found on the company’s website.
Technical analysis is different altogether. In its purest form, it involves making all buy and sell decisions on the basis of share charts, with no regard for what a company is or does.
Basically, it is a form of analysis on historical share prices to predict future price movements. It is based on the concept that if a trader can identify previous market patterns, they can form a fairly accurate prediction of future price trajectories.
Trends, Patterns, Support Levels, Resistance Levels, and Technical Indicators all take part in what a technical analyst looks at to determine a stocks future direction.
Technical Indicators are a graphical representation of a mathematical formula based on historical data of the stock. There are many different types of indicators which are usually used as secondary form analysis after forming a view analysing the chart. There are indicators to help measure changes in volume, momentum, overbought or sold conditions, changes in volatility, etc.
By reading short term price movements and applying these technical analysis principles, traders have a better chance of predicting short term movements. Comparatively, Fundamental analysis relies on data that is slower moving and takes longer for the stock to play out.
Investors can also employ technical analysis principles to better time their entry into a stock. Equally, a trader can back their analysis by understanding the fundamentals of the stock.
In conclusion, technical analysis is a more reliable way to predict shorter term movements. Fundamental analysis is a more reliable way to predict longer term movements. Each camp can benefit from applying both, but should emphasise the analysis best suited to their time frame.
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