Approaches to Equities - Fundamental and Technical

Welcome back friends… it’s been unusually long overdue to write something here. Let’s talk about that and pleasantries can wait.

Well, to start from the very basic, there are two different roads one can take to start trading equities and I mean serious trading. One can simply have few friends giving tips, all those TV anchors acting as messiahs can also help, you can have hunch, dream or a thousand other ways to trade but if you seriously want to be responsible for your own decisions and money then you can take two approaches. You can analyse equities with the help of Fundamental Analysis or Technical Analysis. There is nothing right or wrong with any of this approach and in fact most of the time; most of the traders use both to complement each other.

Fundamental Analysis involves hosts of things including studying Balance Sheet, P&L Accounts, Cash Flow, Income Statements, Results, P/E Ratios, Return on Capital/Equity, etc. Then you also study the sector in which the company operates, short term, long term prospects of the sector, cyclical nature of sector. Next thing you turn to the economy in general, economy of the geography where company operates, country’s economy and now a days world economy too. You also get into analysing the competitors and their progress vis-à-vis the company you are interested in and it does not stop here. You can also factor in political (in)stability, approaching federal budget, policy announcements and virtually everything that can have any trace of effect on the stock. Sounds complicated… it isn’t. There are ways to simplify things a ton.

Technical Analysis, on the other hand, assumes that all these factors and everything else (like zodiac signs, astronomical alignments, etc.) are all factored in in the price of the stock. So if you simply see the price movement of the stock, all these things and their impact is already present there. Another baseline assumption here is that prices tend to follow some patterns and these patterns are repetitive in nature. So sometimes stock may follow one particular pattern and some other time the pattern may be of different kind. If you have some experience in TA (Technical Analysis off course) then you can identify these patterns and trade with them.

In short, TA assumes that Price factors in everything, Price tends to move in patterns and which are repetitive in nature. These three basic assumptions are the key to the whole field of TA.

Some subtle difference between Fundamental (FA) and Technical (TA) approaches are;

• FA needs lot of financial data usually for multiple years but TA can just do about with price (and volume) variation over the time.
• The data needed for FA is not published daily and is available usually every quarter while TA has data updated every second when the market is open.
• Due to its inherent nature, FA is mostly used for long term decisions (investing). TA however can be used for decisions for years, months, weeks or even intraday. While TA is used mainly for trading, it can also be used for investing.

There are supporters and critics of each of these approaches but also there are critics who criticize both these approaches. The later lot emphasize their arguments against both FA and TA based on EfficientMarket Hypothesis (EMH). I will not get into details of that; it will probably need a blog of its own.

Obviously, my Technical Background forbids me to talk about FA first and hence we will discuss TA in details. Next post on types of charts in general and candle-sticks in particular.