Fundamental or technical analysis? What are the differences?

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Each investor who chooses to invest their money in the capital of a company has his own method to determine which company will enable him to obtain the best return on investment.

However, there are two distinct schools of investment in the equity market, which have always been opposed: fundamental analysis and technical analysis. To better understand these two points of view, it is essential to know both methods in order to evaluate the differences.

Basic analysis

This method focuses on the company and all the factors that influence its development, whether they are internal to the company such as its turnover or external elements such as the macroeconomy. The fundamental analyst must therefore be aware of the following elements in order to determine the company’s growth potential:

  • Macroeconomics

The macroeconomic context allows us to have a global vision of the world’s regions and their health states, so it is on this aspect that the analysis must be done first in order to know which area is more favourable to economic development and which area is in difficulty.

To perform an effective analysis, it is necessary to refer to economic indicators and especially to their evolution. These indicators can be found on the economic calendars of most stock exchange or financial market websites in general.

There are many economic indicators for different geographical areas, different aspects of the economy such as employment, price trends or consumer confidence levels. These indicators are published at different times and at different frequencies, they influence companies because they allow a complete diagnosis of the macroeconomic situation.

The fundamental analyst will therefore carefully monitor these macroeconomic figures in order to know which area is the most suitable for investment and once he has determined which geographical area he will choose, he will then be able to carry out an analysis of the different sectors of activity to know the most profitable.

  • Sector analysis

This analysis is done first of all through an in-depth knowledge of the sector’s industry, i. e. all companies, their suppliers and customers.

  • The macro approach focuses on the different external events that can be political, economic, sociological, technological, ecological, legislative… This method of sectoral analysis is called the PESTEL.

  • The micro approach focuses on factors such as the intensity of existing competition, the bargaining power of customers, the bargaining power of suppliers, the threat of alternative products and technologies or the threat of new entrants. These criteria are known as Porter’s forces.

This analysis of the sector allows to know if it is attractive or not for a company and therefore if it will easily develop. The fundamental analyst can then determine whether investing in this sector is a relevant choice or not.

Once the analyst has selected a sector that he believes is favourable to the growth of companies, he must then tackle the core of the problem which is of course the analysis of the company itself.

  • The company’s analysis

The analysis of the company is done in four steps:

  • First of all, it is necessary to determine the company’s business in order to know precisely what its own vision is of its activity and how it is perceived by its environment.

  • A structural analysis is then carried out, here we seek to analyze the company as a whole by seeking the interactions that govern its functioning. It provides a global vision, focusing on management styles, strategy, corporate governance and all competitive advantages.

  • The third step consists in a functional analysis of the company where we study the main functions of the company (production, marketing, sales, R&D, finance,…) to identify its strengths and weaknesses.

  • The last phase of analysis is undoubtedly the most important since it is the company’s financial analysis, it makes it possible to determine, through various documents used as tools (balance sheet, income statement, cash flow statement…), certain essential elements such as the company’s profitability, its debt or its working capital requirement.

The complete analysis of the company allows to know exactly what its strengths and weaknesses are and thus to know if its growth potential is important or on the contrary if it seems to be in decline.

Fundamental analysis is therefore a method that is based solely on factual elements to invest in a company, it is very costly in time because it requires collecting a large amount of information but it allows to have a very precise vision of the health of a company and its future growth prospects.

Due to the very large number of factors that come into play, fundamental investment is often linked to a discretionary approach, i. e. the investor makes decisions himself without an automated program.

The technical analysis

This method is quite different from the previous one, although it obviously has the same objectives, since the technical analyst is not interested in the company when he invests but only in its price and its variations over time, which are represented using the stock market charts that everyone has had the opportunity to see at least once in their lives.

The technical analyst will therefore closely monitor share price prices to determine whether they will rise or fall. To do this, it uses very different concepts from those of the fundamental analyst, such as the notion of trend, to determine whether prices are in an upward or downward dynamic.

Natixis action in a bullish trend

 

  • Support and resistance

He will also look for areas on the graph called support and resistance areas that correspond to price levels that the share price has hit several times without succeeding in pushing them up (resistance) or down (support).

  • Chartist figures

An alternative method for technical analysis is to identify certain patterns of recurrent prices that may indicate a change in price evolution, for example the figure at the top of the shoulder that announces a price reversal.

Figure en tête – épaule

  • The technical indicators

Technical analysts also use mathematical indicators that can help them detect changes in trends and the right time to buy or sell a stock.

There are still many other methods of technical analysis because this is a very large and complex field, but they all aim to understand changes in share prices. Investors who use this method are interested in the psychology of other market participants and think that everything that happens on the market is visible in the price curve.

Investors turn to this method because it is easier to understand and requires less upstream research work, so it is highly valued by the general public. However, this method is very difficult to master and it is important to remember that in terms of investment, there is no miracle recipe for winning every time and that whatever method is used, loss is part of the game.

Unlike fundamental analysis, technical analysis is more related to a systematic approach, therefore based on statistical programs that make purchase or sale decisions themselves when they recognize certain configurations as we have seen previously. </span

Basic or technical analysis, there is a priori no one method that is superior in every respect to the other. However, there are methods that are more appropriate for some people than others. It is up to everyone to know which one allows them to obtain the best results.

What is certain in any case is that these two types of analysis have their advantages and disadvantages and that it would be harmful for an investor to completely denigrate a method when finally the fundamental and the technical are not opposed but are well and truly complementary for understanding the equity market.

Benoît Gueguen

BONDS & SHARES

BONDS & SHARES is a participatory non-Profit information platform for, through and by experts in finance and business. For more information please visit www.bonds-and-shares.com


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