Question

First define the two different concepts of fundamental analysis and technical analysis as applied to evaluating investments. What are the advantages and/or disadvantages of these diverse approaches?.

Answer 1

Fundamental analysis : This method analysis stocks on the basis of certain valuation measures like the dividend discount model and the cash flow model to determine the intrinsic value of a stock. It uses the information of a stock obtained from it's financial statements and news floating about a stock in the market to determine it's true and fair value. Fundamental analysis , time horizon is long term.

On the basis of the results obtained through these models, we can reach a conclusion weather a stock is undervalued or overvalued.

Technical analysis uses charts and patters to determine how a stock is going to move in the future. Based on the past pattern ,we try to evaluate the future price movements. The time horizon of technical analysis is short term.

Advantages of Technical analysis:

• Provides quick and easy information.
• Helps identify patterns and trends of stocks.
• It helps investors determine the entry and exit points as to when to enter or exit a stock.
• It provides lots of information to an investor.

Disadvantages :

• Sometimes trends and patterns do not work and can lead to false conclusions.
• It can create confusion among the investors, as different investors may interpret different results differently.
• Technical analysis is used for trading purposes.

Advantages of fundamental analysis:

• Investors can profit by buying undervalued stocks and selling overvalued stocks, The information about which stocks are undervalued and which are overvalued is obtained from fundamental analysis.
• Fundamental analysis is used to investing purposes.

Disadvantages of fundamental analysis :

• The inputs in the model are extremely sensitive and small changes in the inputs can lead to large changes in the price obtained from this model.
• It is time consuming, as it requires too much data in forecasting.
• In case of efficient markets, information which is publicly available is reflected on the stock, hence no investor can gain by buying undervalued and selling overvalued stocks.