Technical Analysis is the process of forecasting the future financial price movements based on studying the past price movements. Same weather forecasting, technical analysis does not result in precise predictions about the future. Instead, technical analysis can help investors find out what is likely to happen to prices over time. This analysis uses various charts that show price over time.
Technical analysis is applied to all markets: stocks, commodities, or any tradable instruments where the price is influenced by the factores which influence the supply and demand. Price data refers to any combination of open price, close price, high price and low price for any given asset.
Key Assumptions of Technical Analysis
Technical analysis is applicable to assets where the price is influenced only by the supply and demand. If any other forces are coming on the stage, technical analysis does not work properly. In order to be successful, the technical analysis makes three key assumptions about the assets that are being analyzed:
"What" is More Important than "Why"
Technicians, as technical analysts are called, are only concerned with two things:
“What is the current price?
What is the history of the price movement?
The price is the end result of the battle between the forces of supply and demand for the company’s stock. The objective of analysis is to forecast the direction of the future price. By focusing on price and only price, technical analysis represents a direct approach.
Technicians believe it is best to concentrate on what and never mind why. Why did the price go up? There were simply more buyers (demand) than sellers (supply). After all, the value of any asset is only what someone is willing to pay for it. Who needs to know why?
Fundamental analysis is the process of examining the underlying forces that affect the health of the economy, industry groups, and companies. It has the same nature as other financial analysis, it pretends to forecast future price movements. It feels like it has to do with the economy as an entire unit but at the company level, fundamental analysis involves the examination of financial data, management, business concept, and competition. At the industry level, it might be an examination of supply and demand forces for the products offered.
In order to forecast future stock prices, fundamental analysis has to combine economic, industry and company analysis to conclude a stock’s current value and forecast future value. If fair value is not equal to the current stock price, fundamental analysts believe that the stock is either overvalued or undervalued and the market price will ultimately gravitate towards fair value.
Technical analysts consider the market to be 80% psychological and 20% logical. Fundamental analysts consider the market to be 20% psychological and 80% logical. Psychological or logical may be open for debate, but there is no questioning the current price of a security.
Fundamental analysis can be valuable, but it should be approached with caution. If you are reading research written by a sell-side analyst, it is important to be familiar with the analyst behind the report. We all have personal biases, and every analyst has some sort of bias.