The use of Fundamental and Technical analysis has been the subject of controversy for a very long time. There is still no consistent empirical evidence to prove which one works better and to what degree. First, let us look at a brief definition of each strategy and the relevant applications.
In principle, fundamental analysis analyzes all the economic and financial indicators to determine the ‘fair value of a stock or share, while technical analysis uses historical price trends to predict future price movements. Although these techniques have the same fundamental goal, fundamentalism targets long-term investments, while technical analysis produces more immediate results.
Quantitative analysis, on the other hand, is a strategy that is rarely mentioned in trading circles. It analyses financial data to establish a company’s position in the market and gives recommendations on valuation in share price.
While all these techniques have their pitfalls, they provide actionable insights to every investor’s ultimate goal-maximizing returns. That said, before using any of these strategies, there are a few things every trader should know.
Criticism toward Fundamental and Technical analysis
Does Technical Analysis Work?
For many experts, the fact that technical analysis can tell you where the market has been in no way guarantees an accurate prediction of future trends. Over the years, it has been common practice, especially in statistics, to use past trends to infer future patterns. This technique is acceptable in many circles. The fundamental question here is, does it work?
Looking at a recurrent theory, the Efficient Market Hypothesis, the consensus is that there is no full-proof method to determine whether a stock is undervalued or overvalued. This theory also insists that markets are random, and there is no reliable way to predict future outcomes.
The million-dollar question here is, can technical analysis lead to profitable investing? In practice, this strategy works by analyzing historical data to predict future price movement, a system that forms some semblance of reasonable judgment. Although it does not provide any precise way of predicting future trends, it provides a basis for trader analysis. It may not be accurate, but the market bias established over the years means it works to some degree.
Does Fundamental Analysis Work?
Similar to technical analysis, fundamentalism focuses on past empirical data to predict future outcomes. The content here is that the information attained from fundamental analysis including, financial statements from previous company performance and public opinion, may cause bias. This bias will influence forecasting and lead to subjective, inaccurate determinations.
As more people evaluate the same fundamental results, opinions are shaped, and everyone trades the same way. This influx in trading direction creates a self-fulfilling prophecy, where public opinion produces a false positive. The argument here is that empirical research does not help predict future trends but causes people to behave in a way that occasions it to occur.
Traders, reacting to fundamental data, act in a way that influences market forces. This reaction of traders thinking in a certain way leads them to make similar trades and creates a system that produces an illusion of market influence.
The verdict here is that there is more to trading than simply analyzing past data and that these two techniques are not as effective as people seem to think they are.
Both techniques have their shortfalls, but they have proven critical resources for clearly understanding market forces and how they affect price movements.
Which one is Better? Fundamental or Technical Analysis
Any financial expert will tell you that there is no consistent way of determining which of these two methods is better than the other. Although they both seek to maximize returns, they employ a novel approach to achieving this end. The value you get from fundamental or technical analysis will depend on the ultimate end game. Is your target long-term or short-term?
Technical analysis suits day traders and short-term investors, while fundamental analysis provides a solid base for long-term investment. The consensus here is that both operate on their own merits. You can attain the best results by combining the two to develop an effective trading strategy.
Both Fundamental and Technical analysis have varying degrees of efficiency, and it would be very unfair to pit one against the other. They do not operate under the same principles and hence cannot be compared based on operational value.