Choosing investments is a major piece of your portfolio puzzle. Deciding when to buy and when to sell is equally important. The question is: How do you make these decisions correctly? The concept here is about research and as always, there are two major sides—fundamental analysis and technical analysis. Everyone has a different opinion on which one works better, so let's begin with an understanding of both.
Fundamental analysis. Fundamental analysis is a method of evaluating a company or security by attempting to measure its intrinsic value. In other words, fundamental analysts try to determine true value by looking at all aspects of the business, including tangible factors—machinery, buildings, land—and intangible factors such as patents, trademarks, and brand names. Fundamental analysis also involves examining related economic factors such as overall industry conditions, financial factors like company debt or interest rates, qualitative factors including management expertise and industry cycles, and quantitative factors such as debt-to-equity and price-to-equity ratios.
Fundamental analysis produces a value that an investor can compare with the security's current price to figure out whether to buy or sell that security (underpriced equals buy, overpriced equals sell or short). Fundamental analysis uses real data to evaluate a security's value. Although most analysts use fundamental analysis to value stocks, this method can be used for just about any type of security.
Technical analysis. This method of evaluating securities analyzes statistics generated by market activity such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts and other tools to identify patterns that might suggest future activity. Technical analysts believe that the historical performance of stocks and markets are indications of future performance.
What strategy is better for you? There are risks involved with both of these methods. Fundamental analysis takes a long-term approach to analyzing markets, often looking at data over a number of years. The data reviewed is released through quarterly financial statements. Technical analysis uses a shorter time frame, often weeks or days. The price and volume data reviewed is released daily. Therefore, fundamental analysis could mean a gain is not realized until a security's market price rises to its "correct" value over the long run, perhaps several years.
In general, technical analysis is used for a trade, while fundamental analysis is used for an investment. It could also be said that traders buy assets they believe they can sell to someone else at a greater price, while investors buy assets they believe will increase in value. The frequency of trading securities using technical analysis could have both a positive or negative impact and could also lead to increased brokerage and transaction costs. The less frequent trading practices of fundamental analysis could also have a positive or negative impact on your portfolio value, but likely has reduced brokerage and transaction costs.
Whether you're an investor or a trader, using a combination of the two approaches could help you evaluate both the basics of a company and its historical movements yielding a more educated decision.
Good luck and happy investing.
Kelly Campbell , Certified Financial Planner and Accredited Investment Fiduciary, is founder of Campbell Wealth Management, a Registered Investment Advisor in Fairfax, Va. Campbell is also the author of Fire Your Broker, a controversial look at the broker industry written as an empathetic response to the trials and tribulations many investors have faced as the stock market cratered and their advisers abandoned their responsibilities to help them weather the storm.