Fundamental analysis and technical analysis

Security analysis

Security analysis is the initial phase of the portfolio management process. This step consists of examining of risk return characteristics of individual securities. A basic strategy in security's investment is to buy under priced securities and sell over priced securities.

There are two alternative approaches to security analysis, namely fundamental analysis and technical analysis. They are based on different premises and follow different techniques. Fundamental analysis, the older of the two approaches, concentrates on the fundamental factors affecting the company such as EPS of a company, their dividend pay out ratio, the competition faced by the company, the market share, quality of management etc. The fundamental analyst studies not only the fundamental factors affecting the industry to which the company belongs but also the economy fundamentals.

The alternate approach to security analysis is technical analysis. The technical analyst believes that share price movements are systematic and exhibit certain consistent patterns. He therefore studies past movements in the prices of shares to identify trends and patterns. He then rises to predict the future price movements. The current market price is compared with the future predicted to determine the extend of mis-pricing. Technical analysis is an approach, which concentrates on price movements and ignores the fundamentals of the shares.

Fundamental analysis and technical analysis

Fundamental analysis

A method of evaluating a stock by attempting to measure its intrinsic value. Fundamental analysts study everything from the overall economy and industry conditions, to the financial condition and management of companies. In other words, fundamental analysis is about using real data to evaluate a stock's value. The method uses revenues, earnings, future growth, return on equity, profit margins and other data to determine a company's underlying value and potential for future growth.

Security analysis that seeks to detect misvalued securities through an analysis of the firm's business prospects. Research often focuses on earnings, dividend prospects, expectations for future interest rates, and risk evaluation of the firm. Antithesis of technical analysis. In macroeconomic analysis, information such as interest rates, GNP, inflation, unemployment, and inventories is used to predict the direction of the economy, and therefore the stock market. In microeconomic analysis, information such as balance sheet, income statement, products, management, and other market items is used to forecast a company's imminent success or failure, and hence the future price action of the stock.

Technical analysis

Technical analysis is a financial markets technique that claims the ability to forecast the future direction of security prices through the study of past market data, primarily price and volume. In its purest form, technical analysis considers only the actual price behavior of the market or instrument, on the assumption that price reflects all relevant factors before an investor becomes aware of them through other channels. Technical analysts may employ models and trading rules based, for example, on price transformations, such as the relative strength index, moving averages, regressions, inter-market and intra-market price correlations, cycles or, classically, through recognition of chart patterns.

Technical analysis is widely used among traders and financial professionals, but is considered in academia to be pseudoscience. Academics such as Eugene Fama say the evidence for technical analysis is sparse and is inconsistent with the weak form of the generally-accepted efficient market hypothesis. Economist Burton Malkiel argues, "Technical analysis is an anathema to the academic world." He further argues that under the weak form of the efficient market hypothesis, "...you cannot predict future stock prices from past stock prices." In the foreign exchange markets, its use may be more widespread than fundamental analysis. While some isolated studies have indicated that technical trading rules might lead to consistent returns in the period prior to 1987, most academic work has focused on the nature of the anomalous position of the foreign exchange market. It is speculated that this anomaly is due to central bank intervention.