Fundamental vs. Technical Analysis - which is better?
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Fundamental vs. Technical Analysis - which is better?
Technical Analysis (TA)
TA is about analyzing statistical trends of a security using historical data. Technical analysis involves looking at the past trading activity and price variations of a security, with the goal of understanding how the supply and demand of a security might influence its future price changes. By using charts to evaluate price trends and patterns, it's often been possible to find profitable trading opportunities.
TA is usually used for short and medium term trading and can be used for all market conditions in an uptrend or downtrend. It can be used to determine the time and price for buying and selling a security.
The two most common forms of technical analysis are chart patterns and technical (statistical) indicators. From a chart's history, there will be chart patterns repeating themselves and you can predict the outcomes from them.
A technical indicator is a tool that helps traders make decisions in the market. Traders use them to try to predict potential future price movements.
Some indicators work best in certain conditions. For example, the TDS 9 works best in an oscillating and weak bull/ bear market. Combine it with 1-2 other indicators to get good results.
TA is very useful for the following reasons:
1) Determine support and resistance levels for buying and selling at the best prices.
2) Determine the trend of a stock- uptrend or downtrend.
3) Determine whether a stock is overbought or oversold.
4) Determine the momentum - strong or waning.
5) Determine breakouts or breakdowns.
6) Determine trend reversals.
7) Minimize emotions.
TA is used for "buying low and selling high" and commonly used in swing trading where you buy at the bottom of a swing and sell at the top. This is shown in Fig. 1 below.
Fg. 1. SIA.
The letters B and S denote the buy and sell signals generated. Blue indicates using TA and yellow indicates using FA. For example, you bought and sold $SIA(C6L.SG)$ shares at the points in the chart. You can also go short on the stock. That is, sell at the top of the swing and buy back at the bottom. So you can potentially double your profits as compared to just go long on the stock. Because you buy and sell every swing, you can maximize your profits.
If you use the MACD crossover, which is a lagging indicator, you may be a few days late. But it's better late than never and the trend reversal is confirmed. So you may not catch the exact top and bottom, but near to them.
Indicators are used in TA, so little emotion is involved. Though you may choose a higher resistance as your selling price and it's not reached. So there is some greed involved. Hence, emotions are not eliminated but minimized in TA.
When the relative strength index (RSI) is 70, a stock is considered overbought and the price may reverse downwards. And when the RSI is 30, a stock is considered oversold and the price may rebound. But it is possible for the RSI to rise to nearly 100 before falling or the RSI to drop to nearly 0 before rebounding. Hence, TA is not 100% accurate for this reason. Personally, I use TA with an accuracy rate of at least 70%. So a TA trader always set a stop loss at 10%.
Fundamental analysis (FA)
FA gives insights about the financial state of the company through various data points. With FA, an investor can better understand the health of the business before buying its shares. It also considers the financial and economic factors that influence a business. FA involves scrutinizing the financial statements, industry performance, and management quality along with ratios like Earnings Per Share, P/E ratio, Dividend yield, etc. A fundamental analyst scrutinizes everything from earnings, and expenses to assets and liabilities of the company. He has to keep himself updated with micro economic (affecting the company) news and macro economic (affecting the industry) news.
FA is the process of finding the fair or intrinsic value of an asset, with the goal of determining whether the asset is overvalued or undervalued.
A FA person typically uses the 1-year target price (tp) of an analyst report as the intrinsic value. Because of the different assumptions used by each analyst, you can have different ratings ranging from buy to sell and wide-ranging differences in tp for a stock. So you take the average of the tp as the intrinsic value. Because of the 1-year period, there is some uncertainty. The longer the timeframe, the greater the uncertainty. When the market is bullish, the tp is high and may not be reached. Only when the market is bearish, the tp is more reasonable and may be reached. Therefore, just take the analyst's tp with a pinch of salt and use it as a guide.
So a fundamental analyst sells a stock if the price rises above the intrinsic value and becomes overvalued. If the price falls below, it becomes undervalued and he holds the stock until it becomes overvalued. If it is undervalued, it is worth buying for him.
A FA person adopts the "buy and hold" strategy. So if the price falls below his buy price, he will hold for years until it reaches the intrinsic value. He will use the DCA strategy. This is ok if the price doesn't fall much. But in a bear market, the stock price may fall 50% to >90% from the buy price. It is not advisable to keep on averaging. It's better to cut loss at 10% to preserve your capital and average near the bottom.
In Fig. 1 above, assume the FA person bought 1,000 SIA shares in Mar 2020 at SGD5.18. He aimed to sell at an intrinsic value of SGD7.00. After waiting for more than a year, he lost a bit of patience and decided to reduce his tp and sold at SGD6.02 in Jan 2023. This is denoted in the letters in blue. So he sold one time as compared to multiple times by a TA trader.
Analysts say that in the long run, the market and stock will always rise above your purchase price. But this is not always the case as I showed in my article below:
For the FA person, he just uses the intrinsic value and not indicators. In other times, he may use emotions. More mistakes will be made if you are emotionally involved. More details in the article below:
Which is better?
The 2 types of analyses are not mutually exclusive. I DYODD using FA to determine the stocks to buy and then use TA to identify when to buy and sell and at what prices. You shouldn't just use TA because a stock may be oversold because of bad fundamentals. It may be so bad that the company goes bankrupt. A FA person buys a stock so long as it is undervalued, but may not be at the best possible price compared to a TA trader.
The technical analyst trades short and medium term. This reduces the uncertainties as compared to long term by the FA person.
From the SIA example above, the FA person only sold 1 time. The TA trader bought and sold multiple times and traded in both directions, thereby maximizing profits.
The technical analyst minimizes the emotions involved and less mistakes are made compared to a FA person.
Therefore, I conclude that TA is better than FA.
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