Fundamental vs. technical analysis
Fundamental analysis asks what something is worth. Technical analysis asks what the price is doing right now. They answer different questions and suit different time frames.
Learning objective: After this lesson you can tell fundamental and technical analysis apart and judge what each is good for.
Fundamental means: you look at the company. Revenue, profit, debt, competition. From that you estimate what it's worth and compare it with the price on the stock market.
Technical means: you only look at the price. What has it done recently, where did it turn, how much was traded. The company itself plays no part.
Where Each Has Its Place
Both have their place. Fundamental analysis helps over long periods, because in the long run the price follows how the company is doing. Technical analysis targets short periods, when mood and shifts in mood set the tone.
Criticism of Technical Analysis
One thing you should know: technical analysis is disputed, and many of its claims don't hold up when tested. It's a collection of observations, some good, some weak. In this level you get to know it and at the same time learn where its limits are.
Fundamental analysis derives a value from expected future profits and compares it with the market price. Its weakness: even small changes in the assumptions change the result a lot. If Sophie assumes 6 instead of 5 percent growth, a third more can easily come out. The calculated value is therefore more of a range than an exact number.
Assumptions of Technical Analysis
Technical analysis assumes that all knowledge and expectations show up in the price history and that patterns repeat. That clashes with the theory of efficient markets, according to which old prices alone can't earn you excess returns. Studies find real effects for some approaches, above all momentum. For most classic chart patterns they find hardly anything.
Testable Claims
For you as a private investor, another difference matters more than the one between the two schools: the one between testable and untestable claims. A rule that can be written down clearly and tested on old data can be judged. A claim that only becomes clear afterwards can't. Many chart patterns have exactly that property.
Summary
- Fundamental asks about value, technical about the price history.
- Fundamental helps in the long run, technical targets short periods.
- Testable rules can be judged, patterns that only become clear afterwards can't.
Did you get it?
What's the biggest weakness of fundamental analysis?
That even small changes in the assumptions change the result a lot. What comes out is a range, not an exact number.
Which technical approach holds up best when tested?
Momentum. For most classic chart patterns the evidence is weak.
Which distinction matters most for you?
The one between testable rules and claims that only become clear afterwards.
Check your understanding
Your task
Write down two questions that someone using fundamental analysis asks, and two that someone using technical analysis asks. Then assign your own investment horizon, for example twenty years or three weeks, to one of the two approaches and justify it in one sentence.
Sources and further reading
- Lo, Mamaysky and Wang (2000) find statistically measurable effects for individual technical approaches compared to pure random price movement, while the evidence for most classic chart patterns remains weak overall. View source ↗
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