Technical analysis is suitable for short-term trading, such as capturing market rebounds during the 2020 pandemic, with 90% of short-term traders relying on its immediacy. However, its reliance on historical data and noise can lead to about 30% false signals. Fundamental analysis is more suitable for long-term investment, like evaluating the long-term potential of Apple Inc.’s stock based on its 2023 net profit of $94.5 billion, though it requires significant time and can be influenced by subjective judgments.
Technical Analysis
The concept of technical analysis is the study of past prices and volumes data to forecast future market trends. Historically, technical analysis has been based on the assumption that all public information is already accounted for in a stock price, and market sentiment can be analyzed through trend lines or patterns along with other data points. As an example, a technical analysis of the S&P 500 index suggests that every severe market correction during the last decade typically predicts investment potential for a short-term investor with an average recovery rate of up to 12.5%.
One of the benefits of technical analysis is its immediacy. Investopedia reports that 90% of all short-term traders fail and that the overwhelming majority use a technical approach to capture intraday swings and quick profits. Moreover, technical analysis is valid in all types of markets, no matter the trading time and duration, including stocks, forex, and cryptocurrencies. Approximately 82% of cryptocurrency buyers used technical analysis to make choices in 2022, according to CryptoCompare.
Technical analysis is an objective methodology that excludes emotional factors and considerations. On the other hand, there are disadvantages to technical analysis. It depends on historical data, which does not fully represent future trends, posing certain limitations. According to a study by the CFA Institute, up to 40% of technical analysis signals were derailed by unexpected market events.
Fundamental Analysis
This type of analysis evaluates a company by looking at its financials, management, industry, and other fundamental factors to arrive at an intrinsic value. It can be used to provide a long-term outlook for research and investments. For example, Apple Inc.’s 2023 annual report showed $94.5 billion in net profit, which contributes key data for fundamental analysts to calculate an approximate value to determine how much to invest in the stock.
One of the benefits of fundamental analysis is that it works better in investments with a longer time horizon, allowing investors to pick up companies experiencing growth. Holding the stocks of fundamentally sound companies at a discount to long-term value can generate an average annual return exceeding 10% (Morningstar). By doing detailed research on companies and industries, the investor obtains a better overview of investment targets. For instance, fundamental analysis has shown notable success with long-term holdings; research from Morgan Stanley demonstrated that investors analyzing the S&P 500 through this lens had around a 70% hit rate.
Fundamental analysis empowers value investors to find undervalued stocks, providing long-term rewards. For example, Berkshire Hathaway has returned over 20% per annum with a long-term investment strategy based on an analysis of true business fundamentals.
However, fundamental analysis also has downsides. Researching data takes significant time and effort, often requiring weeks or even months to analyze a large multinational company. The value of a company can also be subjective. According to Investors Chronicle, approximately 25% of fundamental analysis reports contain findings influenced by analyst bias.
Which Method is More Effective
Both technical and fundamental analysis have pros and cons depending on the type of investor and market conditions. As a short-term tactic to capture market oscillations, technical analysis is more appropriate. For example, intraday traders using technical analysis typically make around 60 trades per month, according to Day Trade Review.
For long-term investments less impacted by noise, fundamental analysis is more relevant, providing an intrinsic value-based approach. Long-term investors using fundamental analysis hold stocks for about 5-6 years on average (source: Fidelity). Personal biases also influence the choice of analysis method. A survey by eToro found that 45% of investors rely on statistics and charts, while the other 55% focus on company fundamentals.
Market conditions also dictate which method is better. Technical analysis is more useful in volatile markets. For example, during the early 2020 COVID-19 pandemic, technical analysis helped investors capture short-lived rebounds. Fundamental analysis has an edge in stable, growing markets. For instance, the bull market from 2010 to 2020 enabled investors to achieve substantial returns by using fundamental analysis to select high-growth companies.
