Fundamental Analysis vs. Technical Analysis: Combining Them for Optimal Results
When it comes to financial market research, there are two general schools of thought that guide portfolio managers: fundamental analysis and technical analysis. Although each methodology presents itself as mutually exclusive from the other, both can be used in tandem to navigate the complex financial markets. Nowhere is this truer than in today’s bull market, which is both the second-longest and the second-most overvalued in history.
Fundamental analysis often serves as the foundation for evaluating long-term investment decisions. It involves measuring a security’s intrinsic value by evaluating all intrinsic aspects of the business or market. For example, investors looking to buy a particular stock will evaluate the company’s underlying business fundamentals, including earnings, revenue and other key metrics before deciding whether to include it in their portfolio. Investors wishing to buy an entire market, such as the S&P 500, usually conduct a broader analysis of the U.S. economy, monetary policy and specific industry conditions.
Technical analysis is the process of evaluating securities using statistics and charting techniques generated by market activity, such as past prices and volume. Unlike fundamental analysis, technical methods do not attempt to measure a security’s intrinsic value, but instead identify market patterns and trends that suggest where a security’s price may end up in the future based on what it’s done in the past.
The Limitations of an Either/Or Approach
Most analysts, financial institutions and research firms rely heavily and in many cases exclusively on fundamental analysis. This often results in an overly optimistic view of where the market is headed, given the assumption that earnings, revenue and stock prices rise over time. Of course, reality is much different. Historically, equities experience significant volatility, corrections and even bear markets. This was most recently experienced during the 2008 financial crisis, which was described as the worst market downturn since the Great Depression.
From a fundamental perspective, the period following the financial crisis hasn’t been entirely rosy, either. Take the 2015-2016 period as an example. During this so-called “earnings recession,” Wall Street posted five consecutive quarters of profit decline. Revenues have been even worse, and to this day remain close to the same level going back to 2012.
While fundamentals are important for developing a long-term perspective, they are not a good short-term timing tool. Since the market can be expensive or cheap for long periods of time, fundamentals are more of a “valuation snap shot” in time.
Technical analysis, on the other hand, is the preferred method for day traders, who look at short-term patterns to predict future returns. Technical analysis is essentially an evaluation of stock market supply and demand, support and resistance and momentum with the aim of identifying uptrends, downtrends and trend reversals in the market.
Technical analysis provides a short-term view of the market and allows investors to participate in the majority of a market uptrend while avoiding most of the downside. However, as a standalone principle, it is less useful from the perspective of long-term value investing – something most portfolio managers aim to provide.
Integrating Both Approaches
If fundamental analysis provides a long-term view of the market and technical analysis a short-term one, there should be inherent benefits to utilizing both in one’s investment portfolio. Fundamental research gives investors a read on the current valuation of an asset, whereas technical analysis can be used to determine when to buy or sell it to achieve maximum return.
Although fundamental analysis was for decades the preferred approach on Wall Street, the advent of high-frequency trading and computer algorithms have made technical analysis much more important. As high-frequency trading continues to evolve, technical tools will retain their vital role in evaluating market performance.
At the same time, portfolio managers must bear in mind that technical and fundamental indicators sometimes convey conflicting information, as we are seeing today. Many fundamental indicators suggest that the stock market is the second-most expensive in history. On the other hand, the technical indicators suggest the bull market that began in 2009 remains firmly intact. In this environment, turning to an experienced financial advisor may be the preferred approach to navigating financial risks. After all, Buy and Hope is not a strategy, and you can win by not losing.
About The Harvest Group
Based in Waltham, MA, The Harvest Group is a family-owned Registered Investment Advisor (RIA) specializing in family wealth management. Led by Roger H. Ingwersen, CFP®, CIMA®, CRPC®, his son Todd M. Ingwersen, CFP®, CIMA®, and daughter Laurie E. Ingwersen, CFP®, CRPC®, CDFA™, the firm provides individuals, families and family businesses with one-stop, customized wealth management, investment management and financial planning services.
Applying a holistic approach to wealth management, The Harvest Group takes a long-term perspective to growing and preserving individual and family wealth. The family team of certified financial planners understands from first-hand experience that family wealth management is not just about money, but often involves complex and unique issues: family dynamics, amicable conflict resolution, business succession planning, and more.
The Harvest Group Wealth Management, LLC is an SEC registered investment adviser principally located in Waltham, MA. Information regarding our firm’s services can be found at www.myharvestgroup.com. A copy of our current written disclosure Brochure discussing our advisory services and fees remains available upon request.