Throughout modern times investors and traders have adopted various methods to analyze markets to trade stocks. As time progressed, all methods of analyzing stock markets got absorbed into two polar schools of thought- Fundamental and Technical.
Fundamental analysis views that economic forces drive stock prices and thereby involves an extensive examination of a company’s current financial statements. Subsequently, If a stock is undervalued, its price is expected to rise in the long run and if it is overvalued, the stick price may fall over a period of time. On the other hand, Technical analysis views that stock price reflects all underlying financial status of the firm and a thorough analysis of price trends in the past can predict whether a stock price may go up or down. In this way, Technical analysts believe that “It’s all in the price” and that stock prices follow staple patterns.
Fundamental analysts calculate an estimated intrinsic value of the firm using financial statements like Cash flow statements, Income statements, and Balance sheets. Fundamental analysis also involves use of other qualitative estimates like brand value of the company, efficiency of current management, and public recognition to estimate where the stock will head in the long run. Fundamental analysts believe that although stocks show variance in trend in a short period of time, it averages out and the market corrects itself.
Technical Analysis rests on an assumption that price movements are not random and they tend to repeat themselves at similar initial prices. A pure Technical analyst does not care about the fundamentals of a company as he assumes that price discounts all measurable properties of stocks. A variety of indicators like moving averages, breaking of resistance levels are used to identify the trajectory of future price movements.
There are no all-weather techniques for analyzing markets accepted in the trading community. Long-term investors pay more attention to the fundamentals of a company and use Technical analysis sparingly. Legendary investor Warren Buffet had mentioned in one of his interviews that he most often analyses a company as a whole unit and examines the fundamentals to measure its intrinsic value thereby predicting whether it will work well in the long run. Many long-term investors disagree with the idea of repeating price trends and believe that stock prices assume a ‘random walk’ with dependency only on the current financial position.
Benjamin Graham, a pioneer of value investing explains the behavior of stock trends that in the short term, the market behaves like a voting machine- changing itself with popular public opinions. But in the long run, the market behaves like a weighing machine reflecting the fundamental substance of a company. Technical analysis in itself has a wide range of strategies which very often predict conflicting outcomes and are not universal.