Fundamental analysis attempts to calculate the future price of a share by looking at the way a company runs its business — such as what it sells and how it sells it — and how a company’s share price may be affected by external influences.  For example, an increase in the price of oil may drive a firm’s production costs higher and therefore affect their profitability.  By calculating the effect of various factors, fundamental analysis attempts to predict what a company’s share price ‘should’ be, or in other words, the ‘fair value’ for the stock.  Typically, traders using fundamental analysis will buy shares when they believe the current price is below ‘fair value’.

To be completely confident with fundamental analysis, you would need to be sure that you have all the relevant and up-to-date information relating to the company you plan on investing in.  This information consists of a range of factors, including the company’s balance sheet, the future demand for their product, whether a competitor is building something better and even the track record of the CEO.  Usually, at least some of this information is unavailable to the market, which means that traders using fundamental analysis are forced to rely on, at least partly, guesswork.

Because of the difficulty in getting all the information required for fundamental analysis, let alone analysing it, many investors use technical analysis.  Technical analysis studies the way share prices change over time. Technical analysts are also called chartists, because the majority of their work is done by studying charts, just like the charts we use in the Stock Watch Report.  At the StockWatch Report, we believe that using technical analysis will allow us to achieve better returns than with fundamental analysis - but this is just our preference.  Many traders prefer to use a mix of fundamental and technical analysis.

The price of a share — or any security — represents an agreement between buyer and seller.  It is the price at which one person agrees to buy and another agrees to sell.  The price at which a trader is willing to buy or sell a share will depend on their expectation of the future price of the security. If they expect the share price to rise, they will usually buy it; if they think the price will drop, then they will usually sell it.  Thus, we can see that prices are a result of people making decisions, formed in part by their expectations and also by the movement of the share price.

So, when we talk about charting or technical analysis, it is as much a study of human behaviour as it is a study of numbers.  The chart is a representation of the way traders and investors have acted in the past, and we can be fairly sure that groups of people — if not individuals — tend to respond in much the same way that they always have.  In other words, history does repeat.  This is one of the key assumptions that underpins technical analysis.

If prices are based on the expectations of the market as a whole, then knowing what a security should sell for (as is the case in fundamental analysis) becomes less important than knowing what other investors expect it to sell for.  While fundamental expectations will have an effect on the actual share price, these expectations will be factored into any technical analysis, as fundamental expectations have always played a role in pricing and this can be historically charted. 

Technical analysis has another great advantage: it is much easier to learn than fundamental analysis.  With time, study and dedication, anybody can develop the skills and techniques of a professional trader.