1. What is the difference between the technical analysis and fundamental analysis?

What are
the different techniques of analysis?

Ans: - Fundamental analysis generally refers to the study of the economic factors underlying the
price movement of securities or commodities, not the price movements themselves. For the most
part, this form of analysis usually results in longer-term investments and is considered to be a
more conservative approach. At a high level, fundamentalists attempt to quantify the current
value of a stock by gathering data relating to general industry outlook, overall market conditions,
corporate financial strength, historical patterns of sales, earnings, market share, dividends, etc.
Using this data they then try to assign a future value to the stock by interpretation and projection.
The difference between the current and future values reflects the fundamentalist's assessment of
the stock's potential as an investment opportunity. Investment decisions are made based on this
fundamental information relative to other opportunities.

Fundamental analysis maintains that markets may misprice a security in the short run but that the
"correct" price will eventually be reached. Profits can be made by trading the mispriced security
and then waiting for the market to recognize its "mistake" and reprice the security.

Much of the work of the fundamentalist involves accurately projecting earnings going forward
and the factors affecting earnings. In theory, the fundamentalist who can make accurate
projections and who chooses quality securities when they are under-valued and sells them when
they are over-valued can reap substantial profits. Of course, when these assessments are faulty
the result is a tendency to maintain a losing position longer than necessary.

Fundamental analysis is performed on historical and present data, but with the goal of making
financial forecasts. There are several possible objectives:

• to conduct a company stock valuation and predict its probable price evolution,
• to make a projection on its business performance,
• to evaluate its management and make internal business decisions,
• To calculate its credit risk.

Use of fundamental analysis

Investors may use fundamental analysis within different portfolio management styles.

• Buy and hold investors believe that latching onto good businesses allows the investor's
asset to grow with the business. Fundamental analysis lets them find 'good' companies, so
they lower their risk and probability of wipe-out.
• Managers may use fundamental analysis to correctly value 'good' and 'bad' companies.
Even 'bad' companies' stock goes up and down, creating opportunities for profits.
• Managers may also consider the economic cycle in determining whether conditions are
'right' to buy fundamentally suitable companies.
• Contrarian investors distinguish "in the short run, the market is a voting machine, not a
weighing machine Fundamental analysis allows you to make your own decision on value,
and ignore the market.
 • Value investors restrict their attention to under-valued companies, believing that 'it's hard
to fall out of a ditch'. The value comes from fundamental analysis.
• Managers may use fundamental analysis to determine future growth rates for buying high
priced growth stocks.
• Managers may also include fundamental factors along with technical factors into
computer models (quantitative analysis).

Tools of Fundamental analysis

It’s all about earnings. When you come to the bottom line, that’s what investors want to know.
How much money is the company making and how much is it going to make in the future.
Earnings are profits. It may be complicated to calculate, but that’s what buying a company is
about. Increasing earnings generally leads to a higher stock price and, in some cases, a regular
dividend. When earnings fall short, the market may hammer the stock. Every quarter, companies
report earnings. Analysts follow major companies closely and if they fall short of projected
earnings, sound the alarm. While earnings are important, by themselves they don’t tell you
anything about how the market values the stock. To begin building a picture of how the stock is
valued you need to use some fundamental analysis tools.
These are the most popular tools of fundamental analysis. They focus on earnings, growth, and
value in the market. For convenience, I have broken them into separate articles. Each article
discusses related ratios.
A. Earnings Per Share

Comparing the price of two stocks is meaningless as I point out in my article “Why Per-Share
Price is Not Important.” Similarly, comparing the earnings of one company to another really
doesn’t make any sense. Using the raw numbers ignores the fact that the two companies
undoubtedly have a different number of outstanding shares.

For example, companies A and B both earn $100, but company A has 10 shares outstanding,
while company B has 50 shares outstanding. Which company’s stock do you want to own?

It makes more sense to look at earnings per share (EPS) for use as a comparison tool. You
calculate earnings per share by taking the net earnings and divide by the outstanding shares.

EPS = Net Earnings / Outstanding Shares

Using our example above, Company A had earnings of $100 and 10 shares outstanding, which
equals an EPS of 10 ($100 / 10 = 10). Company B had earnings of $100 and 50 shares
outstanding, which equals an EPS of 2 ($100 / 50 = 2).

So, you should go buy Company A with an EPS of 10, right? Maybe, but not just on the basis of
It’s EPS. The EPS is helpful in comparing one company to another, assuming they are in the
same industry, but it doesn’t tell you whether it’s a good stock to buy or what the market thinks
of it.

B. Price to Earnings Ratio

If there is one number that people look at than more any other it is the Price to Earnings Ratio
(P/E). The P/E is one of those numbers that investors throw around with great authority as if it
told the whole story. Of course, it doesn’t tell the whole story (if it did, we wouldn’t need all the
other numbers.)

The P/E looks at the relationship between the stock price and the company’s earnings. The P/E is
the most popular metric of stock analysis, although it is far from the only one you should
consider.

You calculate the P/E by taking the share price and dividing it by the company’s EPS.

P/E = Stock Price / EPS

For example, a company with a share price of $40 and an EPS of 8 would have a P/E of 5 ($40 /
8 = 5).

What does P/E tell you? The P/E gives you an idea of what the market is willing to pay for the
company’s earnings. The higher the P/E the more the market is willing to pay for the company’s
earnings. Some investors read a high P/E as an overpriced stock and that may be the case,
however it can also indicate the market has high hopes for this stock’s future and has bid up the
price.

Conversely, a low P/E may indicate a “vote of no confidence” by the market or it could mean
this is a sleeper that the market has overlooked. Known as value stocks, many investors made
their fortunes spotting these “diamonds in the rough” before the rest of the market discovered
their true worth.

What is the “right” P/E? There is no correct answer to this question, because part of the answer
depends on your willingness to pay for earnings. The more you are willing to pay, which means
you believe the company has good long term prospects over and above its current position, the
higher the “right” P/E is for that particular stock in your decision-making process. Another
investor may not see the same value and think your “right” P/E is all wrong.
 C. PEG

The P/E is the most popular way to compare the relative value of stocks based on earnings
because you calculate it by taking the current price of the stock and divide it by the Earnings Per
Share (EPS). This tells you whether a stock’s price is high or low relative to its earnings.

Some investors may consider a company with a high P/E overpriced and they may be correct. A
high P/E may be a signal that traders have pushed a stock’s price beyond the point where any
reasonable near term growth is probable.

However, a high P/E may also be a strong vote of confidence that the company still has strong
growth prospects in the future, which should mean an even higher stock price.

Because the market is usually more concerned about the future than the present, it is always
looking for some way to project out. Another ratio you can use will help you look at future
earnings growth is called the PEG ratio. The PEG factors in projected earnings growth rates to
the P/E for another number to remember.

You calculate the PEG by taking the P/E and dividing it by the projected growth in earnings.

PEG = P/E / (projected growth in earnings)

For example, a stock with a P/E of 30 and projected earning growth next year of 15% would
have a PEG of 2 (30 / 15 = 2).

What does the “2” mean? Like all ratios, it simply shows you a relationship. In this case, the
lower the number the less you pay for each unit of future earnings growth. So even a stock with a
high P/E, but high projected earning growth may be a good value.

Looking at the opposite situation; a low P/E stock with low or no projected earnings growth, you
see that what looks like a value may not work out that way. For example, a stock with a P/E of 8
and flat earnings growth equals a PEG of 8. This could prove to be an expensive investment.

A few important things to remember about PEG:

• It is about year-to-year earnings growth

• It relies on projections, which may not always be accurate
 D. Price to Sales Ratio

This metric looks at the current stock price relative to the total sales per share. You calculate the
P/S by dividing the market cap of the stock by the total revenues of the company.

You can also calculate the P/S by dividing the current stock price by the sales per share.

P/S = Market Cap / Revenues

Or

P/S = Stock Price / Sales Price per Share

Much like P/E, the P/S number reflects the value placed on sales by the market. The lower the
P/S, the better the value, at least that’s the conventional wisdom. However, this is definitely not a
number you want to use in isolation. When dealing with a young company, there are many
questions to answer and the P/S supplies just one answer.

E. Price to Book Ratio

Value investors look for some other indicators besides earnings growth and so on. One of the
metrics they look for is the Price to Book ratio or P/B. This measurement looks at the value the
market places on the book value of the company.

You calculate the P/B by taking the current price per share and dividing by the book value per
share.

P/B = Share Price / Book Value per Share

Like the P/E, the lower the P/B, the better the value. Value investors would use a low P/B is
stock screens, for instance, to identify potential candidates.
F. Dividend Payout Ratio

The DPR (it usually doesn’t even warrant a capitalized abbreviation) measures what a
company’s pays out to investors in the form of dividends.

You calculate the DPR by dividing the annual dividends per share by the Earnings per Share.

DPR = Dividends per Share / EPS

For example, if a company paid out $1 per share in annual dividends and had $3 in EPS, the
DPR would be 33%. ($1 / $3 = 33%)

The real question is whether 33% is good or bad and that is subject to interpretation. Growing
companies will typically retain more profits to fund growth and pay lower or no dividends.

Companies that pay higher dividends may be in mature industries where there is little room for
growth and paying higher dividends is the best use of profits (utilities used to fall into this group,
although in recent years many of them have been diversifying).

Either way, you must view the whole DPR issue in the context of the company and its industry.
G. Dividend Yield

This measurement tells you what percentage return a company pays out to shareholders in the
form of dividends. Older, well-established companies tend to payout a higher percentage then do
younger companies and their dividend history can be more consistent.

You calculate the Dividend Yield by taking the annual dividend per share and divide by the
stock’s price.

Dividend Yield = annual dividend per share / stock's price per share

For example, if a company’s annual dividend is $1.50 and the stock trades at $25, the Dividend
Yield is 6%. ($1.50 / $25 = 0.06)

H. Book Value

Another way to determine a company’s value is to go to the balance statement and look at the
Book Value. The Book Value is simply the company’s assets minus its liabilities.

Book Value = Assets - Liabilities

In other words, if you wanted to close the doors, how much would be left after you settled all the
outstanding obligations and sold off all the assets.

A company that is a viable growing business will always be worth more than its book value for
its ability to generate earnings and growth.

Book value appeals more to value investors who look at the relationship to the stock's price by
using the Price to Book ratio.
To compare companies, you should convert to book value per share, which is simply the book
value divided by outstanding shares.

I. Return on Equity

Return on Equity (ROE) is one measure of how efficiently a company uses its assets to produce
earnings. You calculate ROE by dividing Net Income by Book Value. A healthy company may
produce an ROE in the 13% to 15% range. Like all metrics, compare companies in the same
industry to get a better picture.

While ROE is a useful measure, it does have some flaws that can give you a false picture, so
never rely on it alone. For example, if a company carries a large debt and raises funds through
borrowing rather than issuing stock it will reduce its book value. A lower book value means
you’re dividing by a smaller number so the ROE is artificially higher. There are other situations
such as taking write-downs, stock buy backs, or any other accounting slight of hand that reduces
book value, which will produce a higher ROE without improving profits.

It may also be more meaningful to look at the ROE over a period of the past five years, rather
than one year to average out any abnormal numbers.

Given that you must look at the total picture, ROE is a useful tool in identifying companies with
a competitive advantage. All other things roughly equal, the company that can consistently
squeeze out more profits with their assets, will be a better investment in the long run.
 Technical analysis
Technical analysis is a method of evaluating securities by analyzing the statistics generated by
market activity, such as past prices and volume. Technical analysts do not attempt to measure a
security's intrinsic value, but instead use charts and other tools to identify patterns that can
suggest future activity.

Just as there are many investment styles on the fundamental side, there are also many different
types of technical traders. Some rely on chart patterns; others use technical indicators and
oscillators, and most use some combination of the two. In any case, technical analysts' exclusive
use of historical price and volume data is what separates them from their fundamental
counterparts. Unlike fundamental analysts, technical analysts don't care whether a stock is
undervalued - the only thing that matters is a security's past trading data and what information
this data can provide about where the security might move in the future.

History of Technical Analysis:

Technical Analysis as a tool of investment for the average investor thrived in the late nineteenth
century when Charles Dow, then editor of the Wall Street Journal, proposed the Dow Theory. He
recognized that the movement is caused by the action/reaction of the people dealing in stocks
rather than the news in itself. Walter Deemer was one of the technical analysts of that time. He
started at Merrill Lynch in New York as a member of Bob Farrell's department. Then when the
legendary Gerry Tsai moved from Fidelity to found the Manhattan Fund in 1966, Deemer joined
him. Tsai used to consult him before every major block trade, at the start of a time when large
volume institutional trading became the norm and the meal ticket for brokers. Deemer, could
recreate market history on his charts and cite statistics. He maintained contact with the group of
other pros around then, who shared their insights with each other in a collegial confidence
worthy of the priesthood.

The field of technical analysis is based on three assumptions:

1. The Market Discounts Everything
A major criticism of technical analysis is that it only considers price movement, ignoring
the fundamental factors of the company. However, technical analysis assumes that, at any
given time, a stock's price reflects everything that has or could affect the company -
including fundamental factors. Technical analysts believe that the company's
fundamentals, along with broader economic factors and market psychology, are all priced
into the stock, removing the need to actually consider these factors separately. This only
leaves the analysis of price movement, which technical theory views as a product of the
supply and demand for a particular stock in the market.
2. Price Moves in Trends
In technical analysis, price movements are believed to follow trends. This means that after
a trend has been established, the future price movement is more likely to be in the same
direction as the trend than to be against it. Most technical trading strategies are based on
this assumption.
3. History Tends To Repeat Itself
Another important idea in technical analysis is that history tends to repeat itself, mainly in
terms of price movement. The repetitive nature of price movements is attributed to market
psychology; in other words, market participants tend to provide a consistent reaction to
similar market stimuli over time. Technical analysis uses chart patterns to analyze market
movements and understand trends. Although many of these charts have been used for
more than 100 years, they are still believed to be relevant because they illustrate patterns in
price movements that often repeat themselves.
How is Technical Analysis done?
Technical Analysis is done by identifying the trend from past movements and then using it as a
tool to predict future price movements of the stock. It can be done by using any of the following
methods:
a) Moving Averages - This method is used to predict the trend and specify various support and
resistance levels in the short and long term period. Most commonly used moving averages are 30
DMAs and 200 DMAs. Where DMA means Days Moving Average.

b) Charts & Patterns—some analysts’ uses charts and patterns to decide on the trend and then
judge the future movement. The tool used by such analyst is converting the chart in one of the
many form of many shapes commonly formed by stocks. Some of such patterns are:

Uses of technical analysis

Technical analysis can be used on any security with historical trading data. This includes
stocks, futures and commodities, fixed-income securities, forex, etc. In this tutorial, we'll
usually analyze stocks in our examples, but keep in mind that these concepts can be applied
to any type of security. In fact, technical analysis is more frequently associated with
commodities and forex, where the participants are predominantly traders.

Trends in Technical analysis

One of the most important concepts in technical analysis is that of trend. The meaning in
finance isn't all that different from the general definition of the term - a trend is really
nothing more than the general direction in which a security or market is headed. Take a
look at the chart below:

Figure 1
It isn't hard to see that the
trend in Figure 1 is up.
However, it's not always
this easy to see a trend:
 Figure 2

There are lots of ups and downs in this chart, but there isn't a clear indication of which direction
this security is headed.

Types of Trend

There are three types of trend:

• Uptrend’s
• Downtrends
• Sideways/Horizontal Trends
As the names imply, when each successive peak and trough is higher, it's referred to as an
upward trend. If the peaks and troughs are getting lower, it's a downtrend. When there is little
movement up or down in the peaks and troughs, it's a sideways or horizontal trend. If you want
to get really technical, you might even say that a sideways trend is actually not a trend on its
own, but a lack of a well-defined trend in either direction. In any case, the market can really only
trend in these three ways: up, down or nowhere. (For more insight, see Peak-And-Trough
Analysis.)

Trend Lengths
Along with these three
trend directions, there are
three trend classifications.
A trend of any direction
can be classified as a long-term trend, intermediate trend or a short-term trend. In terms of the
stock market, a major trend is generally categorized as one lasting longer than a year. An
intermediate trend is considered to last between one and three months and a near-term trend is
anything less than a month. A long-term trend is composed of several intermediate trends, which
often move against the direction of the major trend. If the major trend is upward and there is a
downward correction in price movement followed by a continuation of the uptrend, the
correction is considered to be an intermediate trend. The short-term trends are components of
both major and intermediate trends. Take a look a Figure 4 to get a sense of how these three
trend lengths might look.

Figure 4

When analyzing trends, it is important that the chart is constructed to best reflect the type of
trend being analyzed. To help identify long-term trends, weekly charts or daily charts spanning a
five-year period are used by chartists to get a better idea of the long-term trend. Daily data charts
are best used when analyzing both intermediate and short-term trends. It is also important to
remember that the longer the trend, the more important it is; for example, a one-month trend is
not as significant as a five-year trend. (To read more, see Short-, Intermediate- and Long-Term
Trends.)

Trend lines
A trend line is a simple charting technique that adds a line to a chart to represent the trend in the
market or a stock. Drawing a trend line is as simple as drawing a straight line that follows a
general trend. These lines are used to clearly show the trend and are also used in the
identification of trend reversals.

As you can see in Figure 5, an upward trend line is drawn at the lows of an upward trend. This
line represents the support the stock has every time it moves from a high to a low. Notice how
the price is propped up by this support. This type of trend line helps traders to anticipate the
point at which a stock's price will begin moving upwards again. Similarly, a downward trend line
is drawn at the highs of the downward trend. This line represents the resistance level that a stock
faces every time the price moves from a low to a high. (To read more, see Support & Resistance
Basics and Support and Resistance Zones - Part 1 and Part 2.)
 Figure 5

Difference between Technical and Fundamental analysis

Technical analysis and fundamental analysis are the two main schools of thought in the financial
markets. As we've mentioned, technical analysis looks at the price movement of a security and
uses this data to predict its future price movements. Fundamental analysis, on the other hand,
looks at economic factors, known as fundamentals.

The Differences Charts vs. Financial Statements

At the most basic level, a technical analyst approaches a security from the charts, while a
fundamental analyst starts with the financial statements. (For further reading, see
Introduction to Fundamental Analysis and Advanced Financial Statement Analysis.)

By looking at the balance sheet, cash flow statement and income statement, a fundamental
analyst tries to determine a company's value. In financial terms, an analyst attempts to
measure a company's intrinsic value. In this approach, investment decisions are fairly easy
to make - if the price of a stock trades below its intrinsic value, it's a good investment.
Although this is an oversimplification (fundamental analysis goes beyond just the financial
statements) for the purposes of this tutorial, this simple tenet holds true.

Technical traders, on the other hand, believe there is no reason to analyze a company's
fundamentals because these are all accounted for in the stock's price. Technicians believe
that all the information they need about a stock can be found in its charts.

Time Horizon
Fundamental analysis takes a relatively long-term approach to analyzing the market
compared to technical analysis. While technical analysis can be used on a timeframe of
weeks, days or even minutes, fundamental analysis often looks at data over a number of
years.

The different timeframes that these two approaches use is a result of the nature of the
investing style to which they each adhere. It can take a long time for a company's value to
be reflected in the market, so when a fundamental analyst estimates intrinsic value, a gain
is not realized until the stock's market price rises to its "correct" value. This type of
investing is called value investing and assumes that the short-term market is wrong, but
that the price of a particular stock will correct itself over the long run. This "long run" can
represent a timeframe of as long as several years, in some cases.
Furthermore, the numbers that a fundamentalist analyzes are only released over long
periods of time. Financial statements are filed quarterly and changes in earnings per share
don't emerge on a daily basis like price and volume information. Also remember that
fundamentals are the actual characteristics of a business. New management can't
implement sweeping changes overnight and it takes time to create new products, marketing
campaigns, supply chains, etc. Part of the reason that fundamental analysts use a long-term
timeframe, therefore, is because the data they use to analyze a stock is generated much
more slowly than the price and volume data used by technical analysts.

Trading Versus Investing

Not only is technical analysis more short term in nature that fundamental analysis, but the
goals of a purchase (or sale) of a stock are usually different for each approach. In general,
technical analysis is used for a trade, whereas fundamental analysis is used to make an
investment. Investors buy assets they believe can increase in value, while traders buy assets
they believe they can sell to somebody else at a greater price. The line between a trade and
an investment can be blurry, but it does characterize a difference between the two schools.

The Critics
Some critics see technical analysis as a form of black magic. Don't be surprised to see them
question the validity of the discipline to the point where they mock its supporters. In fact,
technical analysis has only recently begun to enjoy some mainstream credibility. While
most analysts on Wall Street focus on the fundamental side, just about any major
brokerage now employs technical analysts as well.

Much of the criticism of technical analysis has its roots in academic theory - specifically the
efficient market hypothesis (EMH). This theory says that the market's price is always the
correct one - any past trading information is already reflected in the price of the stock and,
therefore, any analysis to find undervalued securities is useless.

There are three versions of EMH. In the first, called weak form efficiency, all past price
information is already included in the current price. According to weak form efficiency,
technical analysis can't predict future movements because all past information has already
been accounted for and, therefore, analyzing the stocks past price movements will provide
no insight into its future movements. In the second, semi-strong form efficiency,
fundamental analysis is also claimed to be of little use in finding investment opportunities.
The third is strong form efficiency, which states that all information in the market is
accounted for in a stock's price and neither technical nor fundamental analysis can provide
investors with an edge. The vast majority of academics believe in at least the weak version
of EMH, therefore, from their point of view, if technical analysis works, market efficiency
will be called into question. (For more insight, read What Is Market Efficiency? and
Working through the Efficient Market Hypothesis.)

There is no right answer as to who is correct. There are arguments to be made on both
sides and, therefore, it's up to you to do the homework and determine your own
philosophy.

Can They Co-Exist?

Although technical analysis and fundamental analysis are seen by many as polar opposites
- the oil and water of investing - many market participants have experienced great success
by combining the two. For example, some fundamental analysts use technical analysis
techniques to figure out the best time to enter into an undervalued security. Oftentimes,
this situation occurs when the security is severely oversold. By timing entry into a security,
the gains on the investment can be greatly improved.

Alternatively, some technical traders might look at fundamentals to add strength to a

technical signal. For example, if a sell signal is given through technical patterns and
indicators, a technical trader might look to reaffirm his or her decision by looking at some
key fundamental data. Oftentimes, having both the fundamentals and technical’s on your
side can provide the best-case scenario for a trade.

While mixing some of the components of technical and fundamental analysis is not well
received by the most devoted groups in each school, there are certainly benefits to at least
understanding both schools of thought.