Fundamental vs technical analysis: two ways of looking at a share

The short answer

Fundamental analysis studies the business behind a share: its revenue, profit, debt and prospects. Technical analysis studies the share's own price and trading history on charts. Neither one predicts prices with certainty.

Think of two people looking at the same made-up company, ABC Limited. The first asks, "Is this a sound business, and what is it worth?" The second asks, "What has the price been doing, and how are buyers and sellers behaving?" Both are looking at ABC. They are just asking different questions.

Many people use a bit of both. This page does not say one is right. It explains what each does and where each falls short. For the basics of shares and prices, see stock market basics.

What fundamental analysis looks at

Fundamental analysis looks at what a company earns, owns and owes, and at the industry and economy around it. It uses the company's results, annual report and other official filings.

Typical questions a fundamental analyst asks:

• Is revenue growing, and is profit growing with it?
• How much debt does the company carry, and can it pay the interest comfortably?
• How does its P/E or P/B compare with similar companies?
• Who runs the company, and how do they treat shareholders?
• What could hurt the business: competition, new rules, rising costs?

The raw material is the company's own disclosures. Our lessons on how to read quarterly results and the P/E ratio explained cover two of the main tools.

What technical analysis looks at

Technical analysis looks at past prices and trading volume, usually on charts, to study patterns and trends. It does not usually look at the company's profit or debt.

Typical questions a technical analyst asks:

• Has the price been moving up, down or sideways over recent weeks?
• Is today's price above or below its recent average?
• How many shares changed hands (the volume) on days the price moved a lot?
• Are there price levels where the share has repeatedly stopped falling or stopped rising?

A common tool is the moving average: the average closing price over a fixed number of recent days. "Closing price" is the official price at the end of a trading day. Technical analysts also use many indicators built from price and volume. Every one of them is calculated from the past.

Time horizons: how long each usually looks ahead

Fundamental analysis is usually linked with holding for months or years. Technical analysis is often linked with shorter periods, from days to weeks, though people use either one over any period.

A fundamental view of ABC rests on things that change slowly, such as how the business grows over several years. Results arrive only four times a year, so a fundamental picture builds slowly.

Prices change every second during market hours, which in India run from 9:15 to 15:30 IST for the normal equity session. That is why chart-based methods are popular with people who buy and sell over shorter periods. Shorter periods also mean more orders, and every order has costs, such as brokerage and taxes, that add up.

The limits of each approach

Fundamental analysis can be right about a business and still wrong about the price for a long time. Technical analysis rests on past patterns, which may not repeat. Losses are possible with either.

Limits of fundamental analysis:

• It depends on reported numbers, which arrive late and can be revised.
• A sound business can still see its share price fall, sometimes for years.
• It involves judgement about the future, and judgement can be wrong.

Limits of technical analysis:

• A pattern that appeared before is no promise it will appear again.
• Two people can read the same chart in opposite ways.
• Sudden news, such as a surprise in results, can break any pattern in a moment.

Neither approach removes risk. Neither can tell you in advance what a price will do.

Side by side

This table puts the two approaches next to each other so you can see the difference at a glance.

One company, two views: ABC Limited

The same made-up ABC Limited looks different through each lens. Here is the arithmetic each side might do, with every number invented.

The fundamental view. ABC's latest quarterly revenue was Rs 1,200 crore, against Rs 1,000 crore a year earlier. (1,200 minus 1,000) divided by 1,000 is 20% growth. Its yearly EPS is Rs 12 and its price is Rs 180, so its P/E is 180 divided by 12, which is 15. A fundamental analyst would then ask: how does 15 compare with similar mobile companies? Is the 20% growth likely to last? What is its debt?

The technical view. ABC's last five closing prices were Rs 176, Rs 178, Rs 181, Rs 179 and Rs 186. Add them: 176 plus 178 plus 181 plus 179 plus 186 is 900. Divide by 5: the five-day moving average is Rs 180. The latest close, Rs 186, is Rs 6 above that average. A technical analyst might note this and look at whether volume rose on the up days.

Notice what each one ignored. The fundamental view never looked at last week's prices. The technical view never looked at debt or growth. Neither view tells us where ABC's price goes next. They are two ways to organise information, not two ways to see the future.

You can feel how prices react to news, with made-up companies and practice money, in our free practice game.

Common mix-ups

Beginners often think one approach is "proper" and the other is guessing, or that a chart pattern or a low P/E is a signal that works by itself.

1. "Fundamental analysis is safe because it studies real businesses." Shares of real, profitable businesses can still fall a lot. Studying the business does not remove risk.
2. "Technical analysis is just drawing lines." It is a structured way of studying price and volume. Its limit is that the past may not repeat, not that it is random.
3. "If a chart shows a pattern, the price must follow." No pattern forces a price to move. Patterns describe the past.
4. "I must choose one forever." Many people use both, and many decide not to trade at all. Learning both helps you understand what others are talking about.

Check yourself, and where to check

Three quick questions, then the primary sources for the raw material each approach uses.

1. A person reads ABC's annual report to study its debt. Which approach is that?
   Answer: fundamental analysis.
2. Closing prices over three days were Rs 100, Rs 104 and Rs 102. What is the three-day moving average?
   Answer: 100 plus 104 plus 102 is 306. 306 divided by 3 is Rs 102.
3. Can either approach predict a share price with certainty?
   Answer: no. Both can be wrong, and losses are always possible.

Where to check: company results and filings, and historical price data, are on the NSE website and the BSE website. The SEBI investor website has free material on investing and on spotting misleading claims. If anyone promises fixed returns from a chart method or a stock tip, check whether they are SEBI-registered on the SEBI website. Registration is not a promise of returns, and no one can promise returns from shares.