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.
[Free Ebook] How should you invest your first $20,000?
We asked 14 Singapore finance bloggers to share what they would do if they could go back in time and invest their first $20,000. They can no longer rewind time, but you can learn from their experience and hopefully start with a better footing.
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.
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.