Which Analysis Philosophy in Financial Markets?

Fundamental Analysis vs. Technical Analysis

Feb 19, 2009

Fundamental analysis studies underlying value, whereas technical analysis focuses on price, as affected by forces of supply and demand.

Analysis of financial markets is usually divided into two main disciplines, known as fundamental analysis and technical analysis. Each are different approaches to the decision making process, in the context of trading or investing in financial markets. In general terms, any market analysis is about selectionof:

Both approaches assume market efficiency. That is, the price of a particular stock, commodity or financial future reflects all the knowable information about that asset at any given time together with the opinions of all market participants regarding that information

Fundamental Analysis

Fundamental analysis approaches the decision-making process by determining the intrinsic value of a financial instrument. For this purpose, the following examples of available economic and financial data may be used:

If the price of an instrument is trading for less than its intrinsic value, its price is expected to rise. Conversely, if the price of an instrument is trading for more than its intrinsic value, then its price is expected to fall.

Fundamental analysis philosophy assumes an efficient market – in which information is disseminated perfectly and is acted on rationally. However, market observation suggests that these assumptions do not necessarily hold, particularly in the short term.

Technical Analysis

Technical analysis approaches the decision-making process by examining the market for the financial instrument itself. It is the study of price activity – more specifically, price patterns – to identify favorable trade opportunities. The data from the market are primarily:

Technical analysis is not concerned with the value of whatever underlies the financial instrument, but with how the forces of supply and demand are impacting upon its price. Technical analysis philosophy assumes:

Hence in analyzing historical price patterns, the technical analyst looks for price behavior that suggests the possible initiation, conclusion, or continuation of a trend.

Which Analysis Method to Use?

The question as to which method is superior is subject to great debate. According to market trader and author, Jack D. Schwager, traders holding “polar-opposite” views regarding the efficacy of fundamental versus technical analysis can each be successful. It is possible to succeed as a trader by being a pure fundamentalist, a pure technician, or a hybrid of the two. The best method depends on the individual.

The primary difference between the two approaches is that fundamental analysis is concerned with the why of market behavior, while technical analysis is concerned with the when.

The copyright of the article Which Analysis Philosophy in Financial Markets? in Investment is owned by Harry P. Schlanger. Permission to republish Which Analysis Philosophy in Financial Markets? in print or online must be granted by the author in writing.