Understanding How Technical and Fundamental Analysis Works

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Annual reports issued by public companies are designed to keep the public informed of how they are performing.  Fundamental analysis is considered the foundation upon which all sound investment decisions are made. The reasons why this type of research is conducted include forecasting future price movements and making determinations about market value.

Various parameters are scanned, analyzed, and interpreted to try and anticipate future price movements of the underlying financial instrument. The concept of overvalued or undervalued is central to the raison d’être of this analysis. In overvalued assets prices are too high and are likely to deflate, while in undervalued assets prices are low and likely to increase in value. The concept of intrinsic value is important when making determinations about overvalued or undervalued instruments.

The notion of intrinsic value is also the fundamental value. It is not the same as the book value, or the market value of the instrument. The intrinsic value is therefore a reference to the real value of a business. In the words of Warren Buffett: ‘… Market price and intrinsic value often follow very different paths – sometimes for extended periods – but eventually they meet.’ This is precisely why we see things like market price corrections in equities, to inflate undervalued stocks, or to deflate overvalued stocks.

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Factors Impacting Company Success

A company’s competitiveness in the marketplace is central to its ability to outflank the competition and deliver profitable returns. It is imperative that competitor analysis is conducted to evaluate the viability of a company for investment purposes. In other words, how is a company positioned relative to its peers for long-term strategic gains? Of course, leadership plays a big part in a company’s success. Leadership includes the owners and shareholders, as well as management and stakeholders across the board. A company’s financial strength is reflected in its ability to meet its debt obligations. Many novice investors typically start investigating a company’s viability after they have purchased stock and market corrections result.

Fundamental analysis is used for evaluating stocks by way of economic analysis and financial analysis. It is designed to predict the future price movements of equities, and it is also a tool for determining what investors consider fair value. It is also an effective way to gauge the quality of management and leadership, as well as the financial strengths of the company in question.

One of the most important reasons for fundamental analysis is to determine a company’s competitive position vis-à-vis other players in the market. Anyone who has an interest in the stock market – whether for trading or investing purposes – will want to consider the fundamentals of the company. These stakeholders include strategic investors, a.k.a. long-term investors, fund managers, value investors (those who see undervalued companies and want to invest in them) and financial advisors.

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How Important Is Technical Analysis?

Technical analysis utilizes charts to ascertain the viability of an investment. Investors and traders can analyze the performance of equities from day-to-day, week to week, or quarter to quarter. The types of charts you use will determine what type of trader/investor you are. Short-term trades will do well with hourly charts. There are even one-minute charts for highly volatile assets which tend to fall into the Forex trading category. Charts appear as bars, lines, candlesticks, or mountains.

 

Each of these time frames is represented on the chart, and they are used by trading experts to anticipate price movements in the asset. Various tools are used in technical analysis, including Fibonacci lines, average directional indexes, Bollinger Bands®, Moving Average indicators (50 day and 200 day), RSI (relative strength index) and Moving Average Convergence Divergence (MACD) among others. Technical and fundamental analysis are used to gain a much better understanding of the underlying financial instrument and the markets to make a more informed trading or investing decision.

Disclaimer: This is a guest post and it doesn’t represent the views of IWB.

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