Any investor invests in assets with two main objectives - protect capital and maximise profits. There are many methods that can help investors obtain information about an asset they want to purchase. Fundamental and technical analyses are two distinct methodologies for evaluating securities and making investment decisions.

This blog will discuss the difference between fundamental and technical analysis.

Fundamental Analysis vs Technical Analysis

Fundamental analysis focuses on the underlying business performance and financial condition of a company to assess its intrinsic value, while technical analysis focuses on the historical market performance of an asset. Let's look into them separately. 

What is Fundamental Analysis?

Fundamental analysis was introduced by Benjamin Graham and David Dodd in 1934. The method calculates the actual value of shares using data from companies' balance sheets. It does not just focus on generating profits and losses that businesses generate, but it also calculates the actual value of a security using the company's situation and compares it with the market value.

Fundamental analysis makes it possible to see if the asset's price is undervalued at a specific time. In short, fundamental analysts calculate the company's worth and compare it to the market price.

How Does Fundamental Analysis Work?

Fundamental analysis lets you decide if an asset is overvalued or undervalued depending on its intrinsic value. For example, let's consider Ethereum. Most decentralised finance (DeFi) runs on its blockchain. If you assume that DeFi will grow, you could predict that the value of Ethereum will increase in the future.

Here is how fundamental analysis works -

1. Identify the company's business model - What products or services does the company sell? Who are its customers? What are its competitive advantages?
2. Analyse the company's financial statements, including the balance sheet, income statement, and cash flow statement. These statements provide insights into the company's financial performance, position, and cash flow generation.
3. Evaluate the company's management team. Do they have a proven track record? Are they aligned with shareholders' interests?
4. Assess the company's industry, market trends and challenges, and position with respect to its competitors.
5. Calculate the company's intrinsic value using discounted cash flow analysis (DCF) or price-to-earnings (P/E) ratio analysis.

After calculating the company's intrinsic value, it can be compared to the current market price. The security is considered an undervalued investment opportunity if the intrinsic value exceeds the market price. On the other hand, if the intrinsic value is lower than the market price, the security is considered overvalued and may not be a good investment opportunity.

What is Technical Analysis?

Technical analysis involves the study of financial markets based on data, quotes, price patterns and future trends. Unlike fundamental analysis, which focuses on the economic, political and social context, technical analysis is purely mathematical and algorithmic, always based on past patterns and data. Therefore, this type of study is best suited to short-term positions and operations.

How Does Technical Analysis Work?

Here's a general overview of how technical analysis works:

• Data Analysis: Analysts plot historical price data to create charts to present the asset's price movement over different periods, such as days, weeks, or months.
• Identify Patterns and Trends: Technical analysts look for patterns and trends in the price charts. Common patterns include support and resistance levels, trendlines, and chart patterns like head and shoulders, double tops, and triangles. 
• Use of Technical Indicators: Technical analysts use a variety of technical indicators, such as mathematical calculations based on price, volume, or open interest data, to gain additional insights into price movements.
• Volume Analysis: Volume analysis confirms the validity of price movements. 
• Confirmation and Risk Management: Technical analysts use various tools to confirm their trading decisions. For example, they may wait for multiple technical indicators to align before trading. Risk management techniques such as stop-loss orders are essential to limit potential losses if the analysis proves incorrect.
• Behavioural Psychology: Technical analysis also incorporates behavioural psychology. It assumes market participants repeat specific patterns and behaviours in the price charts. For example, the fear and greed of investors can lead to emotional buying or selling, causing price patterns to emerge.
• Constant Monitoring: Traders using technical analysis must manually monitor price charts and indicators or use trading tools or software to make timely decisions.  

Conclusion

The choice between technical and fundamental analysis depends on your investment objectives, investor profile and the type of assets you are interested in.

Fundamental analysis is a good starting point to analyse where to invest based on the financial health of the security. Technical analysis is a complementary tool that can tell us when to buy or sell according to market trends and developments.

Both approaches have advantages and disadvantages. They can also be combined to make more informed decisions.