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Investing: Fundamental Analysis vs. Technical Analysis

If you are interested in investing [3], you know that it’s important to find a way of evaluating your potential investments so that you are able to choose what is most likely to provide you with the best chance of a reasonable return.

But how can you determine which investments are likely to provide you with the highest potential performance? There are two main types of analysis that you can use as you evaluate investments: fundamental and technical.

Fundamental Analysis

The first type of analysis deals with the “big picture” items that rely on the basics of an investment. Fundamental analysis relies at looking at underlying factors that can help you create a picture of the investment’s potential staying power. Fundamental analysis is especially effective if you are looking for value investments [4] likely to weather economic cycles and result in long-term success.

Some of the factors considered in fundamental analysis include:

When looking at an investment on a fundamental level, it’s about looking at how strong the asset is now, and how strong it is likely to be in the future.

This doesn’t mean that an asset will always perform well. In some cases, an investment will drop due to market conditions. If a stock is falling along with the rest of the market, it doesn’t mean that the investment is a loser. Take a look at the fundamentals. If the fundamentals are strong, there is a good chance that the stock will recover from the current market turmoil, and that it will perform well in the future. All investments experience setbacks. When you use fundamental analysis to choose assets with likely staying power, though, you don’t have to worry about timing the market [5], since your portfolio is likely to recover.

Technical Analysis

Technical analysis is a little bit different. Instead of looking at the characteristics of a particular investment, technical analysis is concerned mainly with the price action.

Every investment has a price history. With technical analysis, it’s all about the numbers, and looking for patterns in the performance. Those who subscribe to technical analysis insist that it’s possible to use the performance of an investment to make predictions about what is likely to happen next. Patterns in how prices behave, whether you are looking at stocks, commodities, or currencies, are used to make decisions.

When using technical analysis, you need to understand what different patterns indicate. You look at charts that display price performance, and then decide when the best time to enter a trade is (usually when it’s near a bottom and poised to head higher) and when you should exit a trade (often when the pattern indicates that a drop is imminent).

Technical analysis is often used by day traders [6], options traders, and currency traders. Technical analysis is popular amongst those who are making short-term trading options, and trying to make money quickly. It can be a little more difficult to get the hang of using technical analysis to good effect than it is to become adept at understanding what fundamentals make a good long-term investment.

What do you think? Do you prefer fundamental analysis or technical analysis?

(Photo: Emmanuel Huybrechts [7])