Picking your own stocks can feel like being put in the driver’s seat of an unfamiliar spaceship. With an endless supply of data and tools in front of you, how do you get your investing strategy going?
There’s no surefire way to pick companies that’ll perform the way you want (sorry, we really wish there was!), but there are methods that investors use to analyse stocks and make informed investments.
Technical and fundamental analysis are methods that help to narrow your focus and decide when to buy or sell. They use different data sources and can cater to different financial goals, so let's find out which one is more your style.
What is technical analysis?
Technical analysis studies what investors have done in the past to help anticipate what they’ll do in the future. Specifically it looks at how much trading activity there’s been and at what price.
This data helps traders identify chart patterns and forecast price movements. It’s kind of like a weather report, except instead of saying whether the temperature will change, it tries to predict if a stock price will change in the near future.
These short-term forecasts make technical analysis a popular tool for traders who are aiming to profit from quick price fluctuations.
The essential tools for technical analysis are:
Candlestick charts
Bar charts
Line charts
Indicators: calculated based on a stock's price and volume
Moving averages: shown as a line on the chart, this indicator smooths out day-to-day price movement, showing a stock’s general direction and identifying trends.
Calculated by averaging a stock’s closing prices over a set time period
Relative Strength Index (RSI): usually shown beneath a stock’s price chart, this indicator shows the speed at which a stock moves upward or downward and helps traders identify if a stock is overbought or oversold.
Pros and cons of technical analysis
If you’re considering incorporating technical analysis into your investing research, here are some important things to consider:
Pros | Cons |
|---|---|
| Speed: Enables quick decision-making, which is ideal for fast-moving markets | Shortsightedness: Lacks insight into long-term price movements and a company's underlying health |
| Adaptability: With chart data being updated constantly, you can react quickly to sudden changes | Inconsistency: Can sometimes give misleading suggestions, especially in volatile markets |
| Signals: Can help identify if a market is heading up or down | Subjectivity: Analysts can have differing interpretations of the same chart patterns |
| Structure: Provides guidance on when to buy, sell, or hold, which helps reduce impulsive trades | Rigidness: Operates on the assumption that past patterns will repeat, but things are always evolving |
| Versatility: In almost any market where price data is available, you can utilize this method |
Now, if technical analysis doesn’t seem right for you, fundamental analysis is another option.
What is fundamental analysis?
Fundamental analysis hunts for undervalued companies that are full of potential (kind of like finding a diamond in the rough).
This method is great for investors who don’t mind doing a deep dive on a company. By poring over a business’s financial statements and financial news, this helps get to the heart of the business and determine its “real” worth.
While fundamental analysis requires a lot of time and energy up front, the idea is that it can help investors get in early on an undervalued asset and sell it down the road at a much higher price. It’s popular for investors with a long-term investing strategy.
The essential tools for fundamental analysis include:
Company-specific data:
Financial statements: used to find stock fundamentals (a.k.a. key financial information) like revenue, earnings, assets, liabilities, and debt levels
These data points give a picture of the company’s general health.
Management discussion and analysis (MD&A): found in financial reports, and gives insight into the company’s leadership
This information can show if the company is being steered in a sound direction.
Company communications: announcements or marketing activities that the company distributes, which can impact stock performance
Whether it’s the announcement of a new product launch, a successful ad campaign, a product recall, or something else entirely, company communications can deeply impact long-term success.
General market data:
Economic reports: data around the broader economy, including gross domestic product, inflation, and interest rates, are important to consider.
Business news: reporting on the company’s industry and competitors can help inform how the stock might perform in the future.
Pros and cons of fundamental analysis
If you’re considering incorporating fundamental analysis into your investing research, here are important things to consider:
Pros | Cons |
|---|---|
| Time: Ideal for identifying companies with long-term growth potential | Intensiveness: Requires significant research, which demands time and effort to collect information and then analyse it |
| Comprehensiveness: Provides an in-depth view of a company and its environment | Lengthiness: Doesn't offer quick insights for short-term price movements — only long-term |
| Value: Can help identify companies whose stock prices are undervalued | Subjectivity: While based on factual financial data, personal interpretations can lead to different conclusions |
| Thoroughness: Allows for assessment of a company's financial stability and any possible risks in detail | Chance: A fundamentally strong company can have its stock prices fluctuate from unexpected news |
| Expertise: Deep and broad analysis develops a deep understanding of how businesses operate | Lag: Reports are released periodically, meaning data can be quite old by the time it is analysed |
Differences between technical and fundamental analysis
Both of these analysis methods are helpful for gaining a better understanding of the stock market, but as you can see, they approach the same questions from different angles.
Technical Analysis | Fundamental Analysis | |
|---|---|---|
| Goal | Predict future price movements | Find undervalued assets |
| Process | Identify trends | Discover a stock’s intrinsic value |
| Idea | All information is reflected in the price of a stock and history repeats itself | The market may mis-price stocks in the short-term, but it corrects in the long-term |
| Persona | Traders | Investors |
| Timing | Short-term | Long-term |
| Tools | Charts; Indicators | Financial statements; Business news |
| Data | Quantitative | Quantitative; Qualitative |
| Focus | Price movements; Trading volume; Chart patterns | Financial health; Economic forecasts; Industry news |
Technical analysis vs. fundamental analysis: which one is right for you?
If you're a short-term trader who makes quick decisions and wants to capitalize on immediate market shifts, technical analysis could be right for you. But if you want a deep understanding of a business for long-term investments, fundamental analysis might suit you better.
Or don’t choose at all! Some investors combine both methods and use both of these tools at their disposal. For example, by using fundamental analysis, you could pick companies to focus on and then use technical analysis to choose your entry and exit points.
