Technical vs. Fundamental Analysis

From now on, I will aim to provide a link (or links) at the top of each post where you can read a better explanation of the topic, to avoid me feeling like such a fraud. Today, it is from Investopedia: Technical vs. fundamental analysis.

Daily reminder: do NOT use this as a source of facts, think of it more like reddit.

I'm a bit tired today, so I think this will be a short one.

Technical analysis and fundamental analysis are two methods and schools of thought around evaluating whether the price of a stock* is overvalued or undervalued. They both have their advantages and flaws, but what I love about this topic is the fact that if you only hear one side of the argument it seems obvious that it is the only true way of valuation. I would like to make a quick disclaimer that many investors also believe that a good mix of the two is required. The other general thing is that both forms of analysis

Technical Analysis

Technical analysis is the best form of analysis by far. The philosophy behind it states that the market has taken into account all of the external factors when it comes to valuing the stock, and therefore it is useless to try and value it yourself.

By that, I mean that of the millions of people out there researching and investing or selling the stock, it is ridiculous to say that you have more information on the underlying value of it that all of those people. If you have ever tried the 'guess the number of jelly beans' game, you will see where I'm coming from. The average of all the guesses is almost always closer than your guess. In the stonks example, it's even worse, because instead of 6 year olds and their parents, you are up against people who do this as their profession and insider traders (people who have more information than is available publicly and trade based on that, like if the CEO of a company sold all of their stock just before announcing that they were going bankrupt).

In essence, it is impossible to win by trying to play the value game. But, that doesn't mean that you can't make informed buy/sell decision. At least in my understanding, the reason technical analysis works is because it predicts the behavior of other investors. look at the price and volume (amount of stocks traded on a particular day) over time. Let's give a super simple example. In the chart below, the green and yellow lines are moving averages of the price of the stock, and I have circled where they cross. One technical analysis strategy would be to sell when the green line (the shorter moving average) goes below the yellow line (the longer moving average) and buy when the yellow line goes below the green line. For this particular chart, a trader using that strategy would do very well.

Fundamental Analysis

This is by far the best form of analysis. Technical analysis is stupid in 100 ways, but the most obvious is this: If trading were able to be boiled down to an algorithm - like above only more complicated - someone smarter than you would have made a bot to trade based on it, and they would be making practically infinite money. Since this hasn't happened, there must be something about trading that is inherently too hard for bots, and no technical analysis techniques are too hard as by definition they only have 2 inputs.

However, fundamental analysts reject the idea that the market has taken into account all of the external factors correctly, and rely on the idea that buying companies* with good income potential in the future which are undervalued. How to calculate that is very complicated, involving looking at market position, past earnings and making educated guesses about the future of demand for that company's products. Fundamental analysis is making a computer model for how many jelly beans can fit in a jar of various dimensions, then measuring the dimensions of the jar in question and stalking the stall owner on Facebook to determine if they are the sort of person to put cardboard in the middle of the jar.

I read a book called Good Stocks Cheap (available for free here) last year that I would recommend to anyone interested in stonks as it gives a basis in accounting and what the stock market is as well as a method for fundamental analysis.

Afterward

I feel like there weren't enough images in this post so here's a comic about a teen cat.

Please like, comment and subscribe, that forms the base of my dopamine injection during these dark times.

*Actually these methods work more generally on securities (generic term for a set of beep boops of financial value that can be bought or sold, such as a share in a company, an option or a bond), but if you came here for accuracy you will be sorely disappointed.