Investing: Fundamental vs. Technical Analysis

Kara  Johnson
Written by
Kara Johnson
Read Time: 2 minutes

There are a variety of techniques to learn if you're going to invest in the stock market. Whether you take a fundamental or technical approach depends on whether you have a short- or long-term horizon.

One size never fits all. That's why investors have two very different analysis methods at their fingertips. Whether you have the patience to invest for the long term, or the staying power of Don Juan, there's an investment technique that's right for you.

Fundamental analysis

One traditional way to weigh the value of a stock is to dig into the company's financial statements. Sift through cash flow data, income statements, and balance sheets, and use all that information to figure out how much money this business is likely to return to investors as profits in the future. From there, you can estimate a fair price for the stock.

Fundamental analysis takes quite a bit of work, not to mention a bit of training in at least the basics of financial analysis. On the bright side, you'll build up the ability to make these decisions fairly quickly, and will learn how to accurately value a stock. When you find an undervalued company, you stand a fair chance of making a profit.

Because of the workload involved and the Economics 101 valuation focus, this style of analysis works well for long-term investors. After all, the stock market can sometimes take its own sweet time to return an undervalued stock to its proper price. If you're looking for sustained cash flow growth, the success story often takes years to unfold.

Technical analysis

Less patient traders may do better with a technical approach. That means poring over stock price charts to look for telltale signs of future price swings. This philosophy states that, since share prices generally reflect the best estimate of a stock's fair value (thanks to the fundamental analysts!), you should be able to divine the near future from recent trends. The technique doesn't lead to fair valuation estimates, and is generally not suitable for long-term investing. It has use for investors with a shorter-term focus, however.

Technical analysis charts range from day-by-day prices over a few months, down to second-by-second detail in an ever-changing snapshot of market sentiment. Day traders are often heavy users of technical analysis, always looking to ride a "cup and handle" chart pattern to new highs, or shorting stocks that show a "head and shoulders" profile. There are theories of efficient markets and mass psychology behind the catchy names, but some experts see technical analysis as an unreliable form of "black magic."

Investing your way

This doesn't mean that technical analysis is useless-only that you should consider its short-term focus. If you're a "buy and hold" type of investor, learning a bit about fundamental analysis can benefit your nest egg in the long run. Nobody knows your personal finances as well as you do, and only you can decide which investment approach is right for your needs.

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