To pick a stock you must know something about the market as well as the company behind each stock. This is where analysis comes in. It’s what analysts do. It’s something investors need to do as well – even if it’s just to better their understanding of the work stock analysts do.
There are two different stock-picking methodologies and both involve researching and forecasting future growth trends of stocks. One is called fundamental analysis. The other is known as technical analysis.
Related: ALL ABOUT ANALYSTS
Fundamental analysis involves measuring the intrinsic value of a stock. This includes studying everything from the overall economy and industry conditions to the specific financial condition and management of a single company. The former is known as macroeconomics. The latter is referred to as microeconomics.
The end goal of fundamental analysis is to produce a value you can compare with a stock’s current price to determine if that stock is undervalued or overvalued.
Fundamental analysis observes numerous elements that affect stock prices such as sales, price to earnings (P/E) ratio, profits, earnings per share (EPS), as well as macroeconomic and industry specific factors.
Top-Down Or Bottom-Up
Fundamental analysis uses either a top-down or bottom-up method. Sometimes it uses both.
The top-down method analyzes the entire market including global and macroeconomic indicators. It may also analyze a sector, such as Technology or the industry such as semiconductor manufacturers. Finally, it arrives at a specific stock such as Intel Corp. (NASDAQ:INTCA).
The bottom-up approach starts with the stock (Intel). Then it observes trends, market and price movement, company financial statements, interest rates, return on equity (ROE) and many other indicators. The goal is to find stocks that will provide a high return on investment (ROI).
One of the most famous advocates of fundamental analysis is the well-known “Oracle of Omaha,” Warren Buffett.
Technical analysis evaluates securities by studying statistics generated by market activity. This includes past prices and trading volume. Technical analysis does not even try to measure a security's intrinsic value. Instead it uses stock charts to identify patterns and trends that might suggest what will happen in the future.
Technical analysis avoids getting into the “weeds” of fundamentals by assuming that the price of a stock reflects the sum total of the knowledge of all participants in the market. Technical analysis focuses on charts of price movement and various other analytical tools. This is how technical analysis evaluates a security’s strength and forecasts future price changes.
Technical analysis was created from the concepts found in Dow Theory, formulated by Charles Dow. It contains two basic assumptions: 1) the market price of a stock discounts every factor that may influence the stock’s price and 2) market price movements are not random but rather move in patterns and trends that repeat over time.
Technical analysis tries to forecast price movement of just about anything that is subject to the laws of supply and demand. This includes stocks, bonds, futures and even currency. It might be accurate to say technical analysis is the study of market price as affected by the forces of supply and demand.
Related: WHICH STOCKS WILL SURPRISE IN 2018?
Which Type Is Best For You?
As you can see, fundamental and technical analysis are polar opposites. Fundamental analysis focuses on earnings, expenses, assets and liabilities. Technical analysis could care less about those factors and cares only about market activity.
You might accurately guess that there is much debate about which system works best for the individual investor. Further reading and study might help inform you for your personal situation – especially since there is no right or wrong answer.
Meanwhile, use the tools available in FinanceBoards to provide consolidated data and information for whichever direction you decide to go.