Quick Lesson: Fundamental vs Technical Analysis

There are 2 widely used techniques of analysis of share prices. Fundamental analysis which looks at the bottom line of a company, its management, its people and its products / services. Technical analysis generally looks at the stock chart and looks for known patterns that show good potential of breaking out. But which method is the better way to "invest"?

When I say "invest', its really different from "trading". The basis of technical analysis is really an assumption that price patterns are influenced by a company's financial performance, and impending good announcements. Most people who practice technical analysis are essentially, "Traders". They trade on the monthly, or weekly, or even daily basis. They spend lots of time going through charts to find potential break out points. Technical analysis assumes that historical price patterns repeat itself.

However, price patterns may not always repeat itself. When Traders buy shares using TA, they are exposing themselves to the risks of volatility of the daily market. TA teaches market timing. Many investors say you can't time the market. But traders claim they can. But the fact of the matter is, large returns of 100% or more are seldom achieved by trading. This is because Traders don't buy and hold. For most cases, they only hold for less than a month.

"Technical analysis practices market timing. Traders think they can time the market. Investors don't"

As a trader, how many times do you see yourself selling your shares at 20% gains, only to see it climb more than 100% over the next few months, and even 200% over 2 years.

Ask any successfuly investors like Warren Buffett, how do they buy shares? They invest. They look at a company's bottom line, the company's potential and fundamentals, and they buy the company and hold them for 5 or more years. They are the ones making compounded returns of 500% over 5 years. They practice Fundamental Analysis. They do not market time.

"Fundamental Analysts are the ones that make 100% or more gains. Not technical analysts."

Fundamental analysis base an investment on its future value. It really doesn't care about the comany's current P/E ratio. If a company grows at more than 25% PA, the high P/E ratio now, will be even out in future. In fact, most companies with High P/E are the ones that have good growth (>25%PA). Companies with no growth have low P/E. Investors and traders have nothing to look forward to, and no reason to increase the P/E. If you shy away from high P/E companies, you are missing out on good growth companies.

"With good EPS growth, a high P/E ratio is not a problem."

FA believes that over medium and long term, the daily volatility is taken out as share prices always climb in line with a company's earnings.

"FA removes the daily volatility and risks for a long term share appreciations in line with earnings."

You might say that in SGX, large returns (300%) thru fundamental analysis is nearly impossible, compared to the US market. However, you've got to remember that the SGX is very young. Singapore listed companies are young. Given another 50 years, the Singapore listed shares may mature its way to that of USA's.

Many times i hear people telling me that they bought Keppel Corp when its $2.00, and sold it at $4.00, and how they regretted not holding on to it (its $19.00 now). However, looking at their style of investing, they are traders. Many times they come to me telling me they made $1000 yesterday. But thats just 10% from one month. They are not the kind of people who would have held on to a stock. No matter what regrets they have. They are the ones that buy penny stocks in a hope that punters will have interest in them. They buy companies without knowing what the company does. They never learn from their previous experiences.

"You must tune your mentality to be a fundamental investor (holder), not a trader. This way, you will see larger returns."

Though both techniques provide good short term returns, it is Fundamental Analysis that assures an investor large price appreciation, removing all the short term volatility. The way to be a (very) successful is through fundamental analysis, not technical analysis. Fundamental analysis is the way to long term gains, while technical analysis exposes traders to lots of unknowns, and hence, lots of risks, with relatively less gains than FA..