Technical vs. Fundamental Analysis

In the investment world, this is like the rivalry between the NY Yankees and Boston Red Sox.

I find that people are often in one camp or the other. And each will tell you why they are right and how the other group doesn’t know what they are talking about.

The two camps are technical analysis and fundamental analysis.

First of all, we have this word “analysis,” but what is it exactly that we are analyzing? Turns out, we are analyzing investments. For what? Everyone is always trying to predict the future. They are trying to look into a crystal ball to predict what’s going to happen with this investment or that investment. And can you imagine if you had a crystal ball that could tell you if a stock was going up or down? You’d be rich! And that’s why there are so many people trying to find that crystal ball.

Let’s look at the fundamental analysts.

These guys and gals have their own version of a crystal ball. For them, they try to figure out if a company’s stock price will go up or down using fundamental analysis. This means they look at the fundamentals of the company. The fundamentals of a company are all about the inner workings of the company and the economy. They look at the company’s revenue, expenses, assets, and liabilities. Is the company growing? Are they making a profit? Have they borrowed a lot of money? Can they pay it back? They look at the rate of employment in the economy and make projections based on all of these economic factors to determine if the company will do well or not. They look at the fundamentals of the company. Seems reasonable.

What about the technical analysts?

What do they look at? The first thing they say is, “Who cares about the company’s earnings and cash flow and all that other stuff? The real secret to predicting how the stock is going to perform has nothing to do with how the company has performed, but everything to do with how the company’s stock has performed in the past.” Huh?

Technical analysts try to predict the direction of stock prices by studying patterns in what the stock price has done in the past. Their belief is that stock prices are really the result of humans buying and selling, that there is a certain degree of psychology with how humans behave and that stock charts visually show this psychology. They believe stock prices move in trends, again, because humans are humans and tend to act in similar ways given similar circumstances. And that if they can see patterns of what the stock did before, then they think those patterns or trends may occur again. They look at stock charts, which show how a stock has done over time, and try to see these patterns.

“I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.”

Technical analysts have all kinds of funny names for some of the patterns they see in these stock charts. Things such as head and shoulders formation, bullish abandoned baby, climax, and the inverse saucer among others.

If you’ve ever looked at one of those 3D Magic Eye books, or those 3D posters in the mall, and tried to see the image, you have a sense of technical analysis.

Both fundamental and technical analysts swear by their methods.

And, of course, some investors use both. Most investors put more weight on the fundamentals of a company. If you are going to put your hard-earned money into a company, don’t you want to know if the company makes money? If they owe a bunch of debt? I sure do.

As Warren Buffett famously once said, “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.”

Stick to the fundamentals.

The proceeding blog post is an excerpt from Get Money Smart: Simple Lessons to Kickstart Your Financial Confidence & Grow Your Wealth, available now on Amazon.