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Technical & Fundamental Analysis

Education – part 2
What is Technical Analysis?

Technical analysis is a method of evaluating securities and trying to forecast direction of prices through the study of historical market data, primarily price and volume. Generally technical analysis use charts and other tools to identify patterns in historic price data that can suggest future activity so when using technical analysis one must assume that the historical performance of securities and markets are indications of the future performance.

2.1.2 History of Technical Analysis:
The actual methods of attempting to predict probable future prices called technical analysis dates back to 1800’s. However it gained importance since 1990’s due to advancements in technology and through the usage of computer models. Charles Dow is the father of the modern technical analysis in the West. He developed a theory later named “The Dow Theory”, which expresses his ideas on price actions in the stock market. “The Dow Theory” served as an initial basis for further development of technical analysis, and nowadays it still plays an important role in the financial world.

2.1.3 The Dow Theory:
The Dow Theory is based upon three main principles:
– The price is a comprehensive reflection of all market forces. At any given time, all market information and forces are reflected in the prices.
– Prices move in trends that can be identified and turned into profit opportunities.
– Price movements are historically repetitive.

2.1.4 Advantages & Disadvantages of Technical Analysis:
Advantages of technical analysis:
1. The amount data required to conduct technical analysis is considerably less than we would need for fundamental analysis.
2. As technical analysis mostly focuses on identifying new trends and trend reversals it is easier to time the entries and exits for trades using technical analysis.

Disadvantages of Technical Analysis:
1. On some occasions you can get mixed signals, two different indicators will shot contradictory information; meaning one indicator could show a Buy signal while the other one would be showing a Sell signal. This could potentially cause confusion in trading decisions.
2. For technical analysis to work as a major strategy it must be able to accurately predict future trends, which it does not do well with explosive trends and highly volatile and illiquid markets and securities.

2.2 Fundamental Analysis
2.2.1 What is Fundamental Analysis?
Generally applied to longer term investment opportunities the fundamental analysis is a method that attempts to predict the intrinsic value of an investment. It is based on a theory that the security can be overvalued or undervalued and such securities tends to move towards their ‘intrinsic value’ or the ‘fair value’.

2.2.2 Advantages & Disadvantages of Fundamental Analysis:
Advantages of Fundamental Analysis:
1. Fundamental Analysis is a good tool for long-term investments that try to achieve a growth of capital as it will help to identify assets that represent a good value in longer-term investment.
2. One of the most notable but less obvious rewards of fundamental analysis is the development of solid understanding of the business and industry due to the in-depth, extensive research and analysis required to conduct fundamental analysis.

Disadvantages of Fundamental Analysis:
1. Intrinsic or Fair Value is based on assumptions. Any changes in the key fundamental factors such as growth can greatly alter the achievable result of the analysis.
2. Being useful for revealing an undervalued company or a company with a high future growth prospects, it does not provide us with any kind of information that would help with timing the entry and purchase of the assets. In other words, you might find an undervalued stock which prices has been below its intrinsic value, and it could very well hold at that level for substantial period of time before showing any sign of meeting your expectations for near-term growth.