Have you ever lost money in the stock market? Have you ever experienced that the stock (or crypto) you buy in expectation of it rocketing ahead (to the moon) begins to tumble the very next day? Have you ever kept a stock in your account for one year hoping it would come back up but then you end up losing eighty percent of your investment in it? Or are you one of the unfortunate ones that sold a stock in deep red and it ended up rising like your blood pressure the very next week?
If the answers to any of these is a teary-eyed yes, what essentially happened is you couldn't predict the stock movement. You see, the only way to make money in the stock market is by predicting the future performance of a stock. You can buy shares at a lower price now in expectations that it will grow in the future and give you handsome returns, or you may short these shares now at a higher price with the expectation that the share price will drop In future and you will earn money from this downfall. Whether you make or lose money, and how much you make or lose, depends 100% on the correct prediction of the future.
But how do you predict the future?
To be honest, it is impossible to do it right 100% of the time. But we can try and come close enough to make great wealth in the stock market. And to do this, we need analysis, of which there are two types:
1. Fundamental analysis
2. Technical analysis
But what do they both mean and how are they different?
Fundamental analysis:
There’s a hint in the name – fundamental.
Fundamental analysis means analyzing the fundamentals of a company, and not the stock price. The focus of fundamental analysis is on the company itself, and not the share.
Here, we look at how the company is functioning and predict if it will grow in the future and how fast.
Fundamental analysis looks at the company structure, its products, its financial health, its management, how the customers perceive it, what are its sales, expenses, profit and losses, how much assets and debt it has, its cashflow and much more to predict its future prospects
If the company does well, increases its sales and profits, naturally the share price will also go up.
Fundamental analysis is not bothered much by share price or past stock performance, but more on the company itself. It looks at price charts as a consequence of the company performance.
Fundamental analysis is essentially what greats like Warren Buffett, Charlie Munger and Peter Lynch do- the attempt is to find the intrinsic value (true value) of the company and if you can get it at a price lower than its true value, you grab the deal. And just like them, you don’t worry if the stock prices go down thirty percent in the next year, because you are sure in the coming years, it is going to rocket to the moon.
Some common words that you might hear if you dabble in fundamental analysis are: sales, profits, price to earning ratio (PE ratio), ROCE, ROE, debt to equity ratio, intrinsic value, income statement, balance sheet, cash flow, etc.
Often known as “Investing”
Technical analysis:
Now this one is as different as it gets from fundamental analysis. In the first one, we looked at the company. But here, we will look at the stock price chart.
In technical analysis, we try to use the price charts to give us an estimate of the future performance of a stock
Here, we give little importance to the underlying company itself, and much more to the price chart we see before us. We want to predict if the participants of the stock market would want to buy or sell this stock in the future.
In technical investing, we don't care if the company is going up or down. If the stock price chart indicates growth in share price, we are interested.
Various variables such as price movements, volumes, trends, are used to statistically estimate if the price will go up or down, i.e. forecast future price direction
Here, you will use multiple indicators like moving averages, oscillators, relative strength, momentum, to predict the strength of a price chart, meaning its probability of going up or down.
This is what names like Paul Tudor Jones, Peter Schiff, Jesse Livermore or Mark Minervini have done to grow their fortunes.
Often known as “trading”.
Which one is better?
Depends on your temperament really. Some people prefer fundamental investing while some others prefer technical investing. Both have its pros and cons, and both require an equal amount of dedication and perseverance to learn and master.
Both analyses have been able to make fortunes for many, many people and both have equally burnt the fingers of the naïve and the greedy.
Which one should you use?
You don't have to decide right away.
You can delve deeper into both analyses, learn and try it for yourself and choose the one which you find more appealing or understand better.
Personally, I advise you to understand the basics of both. When you are in the stock market, or any market like crypto, commodities, currency, etc, it is wise to be extremely careful with your hard-earned money. The knowledge of both fundamental and technical analysis can help you better see the risks and opportunities in the market. Remember, the markets are not a gamble and you must use every tool in your arsenal to earn money here. It is NOT easy; if it were, we would all have quit our jobs and become full time traders or investors.
Another important word of caution- know exactly why you bought a stock. If you bought it because the company is fundamentally strong, do not sell your stock because of some market volatility. Only sell when the company fundamentals changes. And if you bought the stock based on price charts or technical analysis, don’t be stupid and keep it with you when the whole market is bleeding red.
As Peter Lynch says, "Know what you own and know why you own it."
Comments