There is always comparison between Fundamental Analysis (FA) and Technical Anaylsis (TA). There is enough supporters at each side of the house, claiming FA/TA is more superior than the other. So which is better? FA or TA?
The reason why market participants require FA or TA is because the flow of information is not perfect. This is especially so for the retail investors. Let’s imagine, if you are one of the first few people to know about something, you are able to act faster than most people. You do not need any FA or TA in this case. Hence, as a retail investor, whether you use FA or TA, you are indirectly trying to get this “information” as fast as possible. By getting this “information” faster than most market participants, you will earn a decent profit. In other words, the EARLIER and MORE RELIABLE information you get, the greater your profits. But then again, you can never do it better than the people higher up[ in the information chain.
The 2 considerations we will discuss are TIME and RELIABILITY. Let’s evaluate the pros and cons of FA and TA.
TIME – entry
FA allows you to buy EARLY (sometimes too early). When you spot a fundamentally good stock, you actually prefer to buy it when there is no hype or interest. Both volume and volatility (price fluctuations) would be low. This means that you would have got in earlier than most people, and wait for buying interest to come in when more people recognise the potential of the stock. You would be a very happy man, getting a profit in multiples of your capital invested. But there are 3 other scenarios that can happen. One, you bought too early, and you have to wait for very long, say 5 years, to see the results. Second, you bought early and the stock price went down, and stay down for a long time, proving you are wrong. Third, you bought early and the stock price went down. You recognised your mistake and sold off, only to regret when the stock rebound and reach higher heights.
TA allows you to buy EARLY ENOUGH (but less profits). On the other hand, TA allows you to buy “later”, but still early enough than most investors. TA is not able to prompt you to buy a cold stock. It will only shows a buy signal when the stock has shown it’s potential to move. But of course, you have to sacrifice some profits already. The good news is, you do not have to wait for a long time before you know you are right or wrong.
TIME – exit
FA valuates the stock price (or it is up to you when to sell). FA valuates the “true” stock price based on the earnings of the business. As a FA investor, you would usually sell when the stock price hits the valuation. If not, you are likely to hold as long as possible, provided the fundamentals do not change.
TA cut loss and profit take. For TA, the concept of cutting loss is very much embraced. The priority is to protect capital first. Once the stock price moves against your position and hit your cut loss price, you will get out of the position without questions. There are also some traders who exit when the price hits their profit target. They do this to maintain a consistent risk reward ratio. Others would want to ride the trend till it changes and reap as much profits as possible. But the key point is, TA always determine an exit point and it will save you from a market crash.
RELIABILITY
Maybe let me explain reliability first. When I say reliability, it means how accurate is it to pick a winning stock. We know that you do not need to be 100% right to win money in stocks, but you do need a certain degree of reliability to win money at the end of the day. To determine reliability, we need to know how stocks are priced. In my opinion, stock prices are basically perceptions of value to investors. And the perception is affected by valuation and emotion. Valuation means the expected worth of a particular stock while emotion refers to the state of greed and fear in the market. Sometimes, the price can be closer to the valuation, and at other times, the stock price can be ridiculously high or low.
FA is good at valuation. As mentioned previously, FA is about valuation of businesses. This is an area that FA does well. However, FA is not able to determine the market emotions. Some may argue that as more stocks becomes overvalued, it is a sign the market is euphoric. I would say it may not be so obvious, and it is also possible for you to find an undervalued stock during a bull run. And if the market crashes, your stock goes down with it.
TA is good at identifying market emotion. On the other hand, TA is basically trying to discern market emotions through the charts, and capitalise on the greed and fear of investors. The reliability of TA changes with market conditions. Some methods work badly in volatile market, getting whipsawed constantly. A FA investor would just ignore the volatility.
As you can see, FA and TA cannot cover both the causes of stock price. There are many pros and cons for FA and TA. For me, I like the FA entry, getting in at a discount. I like the TA exit, giving the ability to reap maximum profits and protecting me against a crash. It does not matter which method you use, the most important thing is to find your edge in the market. And it will take time, effort and money to find it.
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{ 20 comments… read them below or add one }
wow, you can really write.
this is a very good piece. what is left is put it into practice and practice.
you are right, both can work, you should use both.
also consider discrete (FA) vs mechanical (TA), both are useful too.
wow, you can really write.
this is a very good piece. what is left is put it into practice and practice.
you are right, both can work, you should use both.
also consider discrete (FA) vs mechanical (TA), both are useful too.
next will be counter trend vs trend following,
short vs long time frame,
day trading vs investor.
bull vs bear and long vs short.
i think i’ll better stop.
next will be counter trend vs trend following,
short vs long time frame,
day trading vs investor.
bull vs bear and long vs short.
i think i’ll better stop.
Thanks coconut. I will take your points and write them in the future. There are so many methods. FA would have value and growth, marco and micro. TA would have trend following and counter-trend, as you have mentioned. I think I should stop too
Thanks coconut. I will take your points and write them in the future. There are so many methods. FA would have value and growth, marco and micro. TA would have trend following and counter-trend, as you have mentioned. I think I should stop too
don’t get me wrong, you shouldn’t stop.
i was a bit surprise when you says “I like the FA entry, getting in at a discount. I like the TA exit, giving the ability to reap maximum profits …”
it shows that despite your lack of trading, you do know some valuable point.
i will further add that, the most important of them all are your phycological make up.
i.e. fear vs bold, pessimistic vs optimistic, pride vs “no pride”, greed vs thrifty….etc etc, they are all asset (not liabilities, it is liability only when you stay too long in it)
learn them all and balance them out, i think you be on your way. thats my opinion.
don’t get me wrong, you shouldn’t stop.
i was a bit surprise when you says “I like the FA entry, getting in at a discount. I like the TA exit, giving the ability to reap maximum profits …”
it shows that despite your lack of trading, you do know some valuable point.
i will further add that, the most important of them all are your phycological make up.
i.e. fear vs bold, pessimistic vs optimistic, pride vs “no pride”, greed vs thrifty….etc etc, they are all asset (not liabilities, it is liability only when you stay too long in it)
learn them all and balance them out, i think you be on your way. thats my opinion.
Think like a fundamentalist , trade like a technician .
Both complement each other. There are 2 kinds of risk: information risk and price risk. Fundamental analysis addresses information risk. Our job is to first of all, ask the right question and then endeavour to dig the information out. Objective, to increase our odds by identifying opportunities and risk exposure.
Price risk , is addressed by technical analysis. Thats basically the discipline of identifying market risk and it’s effect on stock price.
FA is the ‘what’ and TA is the ‘how’ . Whether you are investor or trader, you certainly need both, becoz when you buy stocks, you buy a business (FA) but the stock carries a market risk (TA).
Think like a fundamentalist , trade like a technician .
Both complement each other. There are 2 kinds of risk: information risk and price risk. Fundamental analysis addresses information risk. Our job is to first of all, ask the right question and then endeavour to dig the information out. Objective, to increase our odds by identifying opportunities and risk exposure.
Price risk , is addressed by technical analysis. Thats basically the discipline of identifying market risk and it’s effect on stock price.
FA is the ‘what’ and TA is the ‘how’ . Whether you are investor or trader, you certainly need both, becoz when you buy stocks, you buy a business (FA) but the stock carries a market risk (TA).
wow, ryan thats a bit too deep for me.
when you says technician, are you referring to applying a pure mechanical trading system?
how would FA comes into play? and what if they both gives contridicting signals? one buy and one sell?
wow, ryan thats a bit too deep for me.
when you says technician, are you referring to applying a pure mechanical trading system?
how would FA comes into play? and what if they both gives contridicting signals? one buy and one sell?
Hi Coconut. When I say technician, I mean applying technical analysis.
They WILL give contradicting signals. Infact at times, when information risk is high (ie when theres little information about the co) , the price risk is low ( ie price earnings ratio is single digit , coz nobody wants to buy something that they dont know) . And vice versa, when analysts starts publishing Buy calls on the co, well, half of singapore would already know it, information risk is low becoz analysts already covers it, and price gets bid up thus resulting in high price risk. So how do you balance it?
This is when buffet’s advice is very pertinent. He only buys something that he understands. Risk come from not knowing what you are buying. I think a firm understanding of fundamental analysis, can swing quite a bit of odds in your favor. TA? That depends isnt it. If you are looking at weekly charts for your investment, you dont really bother what the 4 hr chart or even daily chart tells you. Thats my 2 sense worth. Hope i didnt confuse anyone. He He.
Hi Coconut. When I say technician, I mean applying technical analysis.
They WILL give contradicting signals. Infact at times, when information risk is high (ie when theres little information about the co) , the price risk is low ( ie price earnings ratio is single digit , coz nobody wants to buy something that they dont know) . And vice versa, when analysts starts publishing Buy calls on the co, well, half of singapore would already know it, information risk is low becoz analysts already covers it, and price gets bid up thus resulting in high price risk. So how do you balance it?
This is when buffet’s advice is very pertinent. He only buys something that he understands. Risk come from not knowing what you are buying. I think a firm understanding of fundamental analysis, can swing quite a bit of odds in your favor. TA? That depends isnt it. If you are looking at weekly charts for your investment, you dont really bother what the 4 hr chart or even daily chart tells you. Thats my 2 sense worth. Hope i didnt confuse anyone. He He.
Information Risk:
Information needs to be assessed on 2 aspects.
Availability: is the info available? How do I get the info? Bill Gross was meditating (he was standing on his head, no joke) and it dawn upon him that the u.s. housing market was very huge bubble. He despatched his analysts all over the country for a few weeks to get a sense of the housing market , digging info, before he came about with the conclusion that the end is near.
Assessment: the information is available but was it rightfully assessed? Dubai collapsed in Nov 2009 but it was not until May 2010 that PIIGS got hit. Imagine, there was a 5months lapse from availability to assessment. Was market efficient? Definitely not. And when Euro collapsed in May 2010 , many didnt realise that it has started falling since Nov 2009.
At times Buffet takes 5 minutes to decide on an acquisition. Questioned at one time about the lack time spent on due diligence in those situation, he said , ‘it took 40 years of work to come out with 5 minutes of decision’
Information Risk:
Information needs to be assessed on 2 aspects.
Availability: is the info available? How do I get the info? Bill Gross was meditating (he was standing on his head, no joke) and it dawn upon him that the u.s. housing market was very huge bubble. He despatched his analysts all over the country for a few weeks to get a sense of the housing market , digging info, before he came about with the conclusion that the end is near.
Assessment: the information is available but was it rightfully assessed? Dubai collapsed in Nov 2009 but it was not until May 2010 that PIIGS got hit. Imagine, there was a 5months lapse from availability to assessment. Was market efficient? Definitely not. And when Euro collapsed in May 2010 , many didnt realise that it has started falling since Nov 2009.
At times Buffet takes 5 minutes to decide on an acquisition. Questioned at one time about the lack time spent on due diligence in those situation, he said , ‘it took 40 years of work to come out with 5 minutes of decision’
ryan, thanks for the explanation.
ya, never listen blindly to the analysts reports. other wise, they themselves will be rich. no need to be an analyst.
ryan, thanks for the explanation.
ya, never listen blindly to the analysts reports. other wise, they themselves will be rich. no need to be an analyst.
haha, make sense.
it took me whole day and night to think. 5 second to execute.
haha, make sense.
it took me whole day and night to think. 5 second to execute.
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