Thanks to Search Engines, a vast amount of information is available on stocks. While this has certain advantages, it has equally become difficult to pick the parts which are reliable and relevant. There are two basic types of analysis undertaken for selecting a stock for investment purpose – Fundamental analysis and Technical analysis.
Fundamental Analysis
One of the basic and crucial aspects of healthy stock-picking is carrying out Fundamental Analysis for a particular company. Fundamental analysis means evaluating a security by studying the various factors associated with it. Like the revenue of the company, its profits (past and present), the debt repaying capacity and its immediate contemporaries.
“You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you’re not ready, you won’t do well in the markets.”
– Peter Lynch
Fundamental analysis helps in creating a financial horoscope of the company and in essence, provides the investor a clear picture of the security he/she wishes to invest in. All investment worth companies have some common attributes that sets them apart. Similarly, all wealth destruction have some common traits which can be seen by an astute investor.
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Fundamental Analysis is the technique that gives you the conviction to invest for a long term by helping you identify these attributes of wealth creating companies. There are many tools which help conduct this fundamental analysis, for example study of audited financial statements, ratio analysis, study of industry data and company news.
Technical Analysis
Technical Analysis is the study and use of various charts and other technical indicators to make trading decisions. Using past stock price and volume data (also known as market action), technical analyst tries to predict future price movements. The actions of markets participants can be visualized by means of a stock chart and patterns can be observed therein. The job of a technical analyst is to identify these patterns and develop a point of view.
Technical analysis particularly helps in generating short term trading plans. Believers of this approach do hold position for a short time span with a view to capitalize on opportunities created by price fluctuations. Technical analysts observe support and resistance levels to identify points on a chart where a pause or a reversal of the prevailing trend is likely to occur. Finally to decide the entry and exit from a particular stock.
“The four most dangerous words in investing are: ‘This time it’s different.'”
– Sir John Templeton
There are too many types of charts and techniques used for technical analysis, each serving a distinct purpose. For example, line charts, bar charts, candlesticks, moving averages etc. With the use of specialized software programs, many of which are available off the self, even ordinary investors with basic understanding of computers can use them for trading decisions.
Should you choose Fundamental Analysis or Technical Analysis?
Generally speaking, time horizon is the factor which guides whether technical or fundamental analysis makes sense. It is generally believed that short-term investors follow technical while long-term investors are better to follow fundamentals. Being open to combining styles may provide the best opportunity to make the most of the market opportunities. Fundamental analysis can be used to identify appropriate targets, while technicals can be followed to make the trading decisions. Together, these methods can generate a confluence providing a better investment opportunity than either used alone.
No matter which approach you take, it’s always important to do your research. You have to read books, attend webinars and consult with a registered investment adviser before risking money in the market. Successful investors have an extremely systematic approach to the markets. They use specific strategies that have been researched upon and deliver time-tested results.
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Small and ordinary investors need to take care of one more aspect – that investing in mutual funds is better than investing in individual stocks, at least to begin with. The rationale behind this is quite simple – buying a single stock is lot riskier than buying a mutual fund. By nature, mutual fund invests in a larger pool of stocks which are carefully selected by a qualified and professional fund manager. This minimize the risk of stocks losing the value at the same time. Once you become conversant with markets, you may proceed towards investing in select stocks, and later even may like to participate in derivative markets.
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