Approaches to investment
In this article, Henri VANDECASTEELE (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2021-2022) explains the two main approaches to investment: fundamental analysis and technical analysis.
Fundamental analysis
Fundamental analysis (FA) is a way of determining the fundamental value of a securities by looking at linked economic and financial elements. Fundamental analysts look at everything that might impact the value of a security, from macroeconomic issues like the state of the economy and industry circumstances to microeconomic elements like management performance. All stock analysis attempts to evaluate if a security’s value in the larger market is right. Fundamental research is often conducted from a macro to micro viewpoint in order to find assets that the market has not valued appropriately. To get at a fair market valuation for the stock, analysts often look at the overall status of the economy, then the strength of the specific industry, before focusing on individual business performance.
Fundamental analysis evaluates the value of a stock or any other form of investment using publicly available data. An investor, for example, might undertake fundamental research on a bond’s value by looking at economic variables like interest rates and the overall status of the economy, then reviewing information about the bond issuer, such as probable changes in its credit rating.
The aim is to arrive at a figure that can be compared to the present price of an asset to determine whether it is undervalued or overpriced.
Fundamental analysis is based on both qualitative and quantitative publicly available historical and current data. This includes company statements, historical stock market data, company press releases, financial year statements, investor presentations, information found on internet fora, media articles, and broker/analyst reports.
Technical analysis
Technical analysis (TA) is a trading discipline that analyzes statistical trends acquired from trading activity, such as price movement and volume, to evaluate investments and uncover trading opportunities.
Technical analysis, as opposed to fundamental analysis, focuses on the examination of price and volume. Fundamental analysis aims to estimate a security’s worth based on business performance such as sales and earnings. Technical analysis methods are used to examine how variations in price, volume, and implied volatility are affected by supply and demand for a security. Any security with past trading data can benefit from technical analysis. This includes stocks, futures, commodities, bonds, currencies and other securities. In fact, technical analysis is much more common in commodities and forex markets where traders focus on short-term price fluctuations.
Technical analysis is commonly used to generate short-term trading signals from various charting tools, but it also helps to improve the assessment of securities strengths or weaknesses compared to one of the broader markets or sectors increase. This information helps analysts improve their overall rating estimates.
Technical analysis is performed on quantitative data only that recent and historical, but publicly available. It leverages mainly market information, namely daily transaction volumes, stock price, spread, volatility, … and performs trend analyses.
Link with market efficiency
When linking both approaches to investment to the market efficiency theory, we can state that fundamental analysis assumes that financial markets are not efficient in the semi-strong sense, whereas technical analysis assumes that financial markets are not efficient in the weak sense. But the trading activity of both fundamental analysts and technical analysts make the markets more efficient.
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Useful resources
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About the author
The article was written in November 2022 by Henri VANDECASTEELE (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2021-2022).