Fundamental and technical analysis

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Abstract

In current society, fundamental and technical analysis is used in company to analyze financial statements. But there is no identical that which approach is more profitable. In this essay, the comprehension and comparison can be researched in order to identify the advantages and disadvantages of the two approaches and propose suggestions to the company.

Introduction

Fundamental analysis and technical analysis are two kinds of approaches to analyze company financial statements. Some traders use them alone and some others associate them together (Talati,2002).But no matter how do they use, the two approaches aim to optimize company profit and help managers conduct the operation. In the first and second part, fundamental analysis and technical analysis are invested and in the third part, the differences and connection are researched and get the conclusion which is profitable for company financial statements analyzing.

Critical discuss of fundamental analysis

Definition of fundamental analysis

Fundamental analysis involves analyzing financial statement, management and market and competitors. It focus on identify the fundamental value, production, interest rate and economy of the company. Fundamental analysis is the research of a company with the calculating the performance value and operation (Finweek,2006). In addition, it is a kind of investment which is the essential element of the asset managers (Moube A and Jannach M, 2003). As the historical mentioned, fundamental analysis start from a company's financial analysis, investors research the financial statement of the company and investigate its advantages and problem to forecast the future direction (Oglesby,2003).

Explain the procedure of fundamental analysis

As above mentioned, fundamental analysis is a way to find the fundamental financial level of the company. The analysis aiming to investigate the financial health and estimate intrinsic value (Finweek,2006). There are three elements of fundamental analysis: economics analysis, industry analysis and company analysis. Each of the three analyses can express the intrinsic value of the company. If the intrinsic value is higher than market price, investor should take some measures to buy or share. In addition, company's fundamental or intrinsic value is decides by financial statement information. Firstly, share received from investor and supplier. Then amount of debt can examined the health of its operation by using debt to equity ratio and the current ratio. Thirdly, computing price/earnings ratio and PEG value to modify some measurement and ensure the growth of company (Elleuch and Trabelsi,2009).

Two approaches of fundamental analysis

Fundamental analysis is one of professional analysis either in stock broking (sell side) or asset management (buy side) research forms (Finweek,2006). Moreover there are two approaches of fundamental analysis: top-down and bottom-up investing.

The top-down approach

The top-up investing approach analyze with global economics, it comprised by international and national indictors such as GDP growth rates, exchange rates, interest rates, productivity and inflation (Wikipedia,2009). Generally speaking, top-down invests company's operation environment and examine the current strategy to predict future performance. Moreover, the approach includes macroeconomic, social and political activity which is useful for estimating the operation of the company. The main benefit of this approach is guarantee some relevant information keep in accordable which cannot cause conflict (Finweek,2006).

The bottom-up approach

The bottom-up approach concentrates on specifically business and research different company of different invest ways. Bottom-up investing usually used in larger scale compared top-down used in local scale (Menge et al, 1997). To evaluate the influence of bottom-up factor in a global company, if the ecosystem is multiple and complicated, we should use different ways to match them. At first, the individual basic elements should be in great detail, and then this detail link together to develop a subsystem which can help company achieve global purpose (Pereira,1993).

Critical discuss of technical analysis

Definition of technical analysis

Technical analysis is a kind of security analysis which aim to describe the trend of company in future and the change of trend based on price and volume. Moreover, technical analysis does not attention for value, information and price can be predicted by historical data (Wikipedia,2009). Usually, technical analysis is named chartists because graphical presentations of their trading rules are used (Mizrach and Weerts,2009). Compared with fundamental analysis, technical analysis is more academic and practical, it usually discover the potential of previous price and then forecast the future equity value for managers (Battman et al,2009).

Characteristics of technical analysis

Technical analysis is based on price and volume transformation to examine different capacity of trading rule. For example, technical analysis can help manager realize the

earning profits by using relative strength index, moving average and inter-market correlations, etc (Battman et al,2009). Besides, technical analysis can illustrate the current and future share price and equity returns especially the random walk hypothesis which past price and predictable future return is identical agreement (Lo and MacKinlay, 1988, 1999). In addition, technical analysis studies the profitability of strategy which includes construction of portfolio at the foundation of historical measurement (Jegadeesh and Titman, 1993,2001). Because of that, technical analysis predict price movement based on historical performance make positive return in future by risk evaluation and capital management.

Principles

Prices move in trends

When the market turn up or down, along with the price changed. Specifically, when the stock rose, sellers go into the market and sell the stock. There are various elements caused the changed such as perceived risk , market volume, analyst rating change and return (Mizrach and Weerts,2009). For example, a experiment conducted by Huddart et al(2007) which research of 52 weeks changed of price. The trading volume raises obviously when the variation of trading range, and the trend is abnormal at least 2 weeks.

History tends to repeat itself

Investors believe that the trend can repeat several times because the behavior always repeats itself usually. Based on the price, technical indicators describe the state of market participant and operation but the behavior is not variable (Collins, 2001).

Compared two analysis used in analyzing company financial statements

Financial statement is an outline of company's activities, operation and investment from a period of time. Information and data from financial statement reflect the financial situation and business operation of the company which is useful for investors and managers making decision and control. From the financial statement analysis, investors can obtain insight of the enterprise including strength and weakness and then advance the strength and diminish the weakness (Malhotra,2008).

Fundamental analysis used in company financial statements

Financial ratio

Fundamental analysis focus on financial ratio which comes from balance sheet, income statement and statement of cash flows. From the financial ratio, managers can get the comparison of the company and other company in the same industry, topmost company in the industry and the condition of previous year of the same company. By using fundamental analysis, financial ratio is a clear way to describe the company position relative to against its peers and get the conclusion of strength and weakness and then make a future strategy to the company. Firstly, debtor turnover can reflect a firm's activity. Specifically, turnover represents the inventory circulating rate. If the turnover is high, it means commodities sold quickly. In another word, the company activity is frequently (Wikipedia,2009). Secondly, current ratio can reflect the liquidity. As we all know, current ratio is equal to current assets over current liabilities. As a result, current ratio is significant relevance to liquidity because 1 percent increase of current ratio can cause more decrease in debt-equity ratio and debt-assets ratio (Toby,2007). Thirdly, gearing or leverage reflects financing. Therefore, change in leverage effect debt and stock so it demonstrate the return differences from different companies (Ozdagli,2009).

Global economics and environment

In current society, global trade develops more quickly than the whole world GDP. In addition, the environment became more and more international too, so it means the firm should face more competitive challenge. As fundamental analysis, it focus on the whole state economy, interest rate and earning. When the amount of currency became reduced or the currency demand become increasing, fundamental analysis can research the forward decision and interest rate which have strengthening and weakening effect to the financial statements. Although foreign investments is effected by high interest rate which can improve the local currency (McDonald,2007).

Technical analysis use in company financial statements

Owing to some problems which effect public value arisen in financial statements, investors prefer to use technical analysis verifying their attitude. Movement of price and volume can demonstrate the financial information by daily operation (Standfield, 2005).

Predict by historical data

Technical analysis like a weather forecast which compare the past and present weather condition and predict whether need to bring umbrella if you want to go out. Actually, technical analysis predicts the trend to decide whether buy or sell (McDonald,2007). If the prediction would be accurate, some measurement should be taken during the technical analysis. For example, in order to foresee the trend of price, investors always random walk. The random walk model is known but its implication for technical analysis is hard to understand. Firstly, the price should constituent organized and last to the future. Secondly, investors use random walk model to predict the future trend. Specifically, the model can be describe,P means price and t means days. E()=0,E( During this model, the prediction price based on the current price . For one period prediction, = = +=. In addition, for two period, the formula is similar: = = +=+. Because of that, the error of prediction is var ((=, var (((=. So based on the pattern, we can get a conclusion that var (=. From the model, the average of price may not be altered but the individual agreement must be random. In that condition, trend of future under technical analysis can be gainful. For instant, if the primary data shows a downtrend, then investors can adopt a short location until the trend became increased. After that, a long location takes place to the short one and make sure the development stable (Tomek and Querin,1984).

Differences and connection between technical analysis and fundamental analysis

As mentioned above, the two approaches analyses are not total different. If a company use the mix analysis, fundamental analysis focus on the reason why price will change while technical analysis focus on when will the price change. As a result, it is the best way to integrate the two approaches. Therefore, if a fundamentalist look through technical analysis, some new discoveries such as new way to access the market or obtain the capital market share. It is resemble that technician use fundamental analysis to research the trade in market (Talati, 2002).

Although there are some benefits to combine the two approaches, some limitations are existed. Technical analysis is good at control risk but it suitable for both short team and long term so that it is not applied in fundamental analysis sometimes which only use long term. In addition, fundamental trader can make decision depend on his own discretion while technical trader should rely on the investor or computerized design (Talati, 2002).

Conclusion

In summary, both fundamental analysis and technical analysis are important to analyze company financial statement. Although there is some differences between them, the two approaches are not incompatible. Managers and investor could use the two approaches or use one of them depend on the market condition to optimize the profit of company.

References

Battman,J et al(2009).Fundamental and technical analysis:substitutes or complements.

Accounting and Finance. 49 (2009) 21-36

Collins,D (2001). Trend Forecasting with Technical Analysis. News, Analysis &Strategies for Futures, Options & Derivatives Traders.30(5).83-85.

Elleuch, J and Trabelsi, L(2009). Fundamental Analysis Strategy and the Prediction of Stock Returns. International Research Journal of Finance and Economics. 30.95-107.

Fineweek (2006). Explaining fundamental analysis. Business Source Complete 8/3/2006.43-44

Jegadeesh, N., and S. Titman, 1993, Returns to buying winners and selling losers,

Journal of Finance 48, 65-91.

Jegadeesh, N., and S. Titman, 2001, Profitability of momentum strategies: an evaluation of alternative explanations, Journal of Finance 56, 699-720.

Lo, A., and A. MacKinlay, 1988, Stock market prices do not follow random walks: evidence from a simple specification test, Review of Financial Studies 1, 41-66.

Lo, A., and A. MacKinlay, 1999, A Non-Random Walk Down Wall Street (Princeton

University Press, Princeton, NJ).

Malhotra,D (2008). Financial analysis using data envelopment analysis. 2008 Northeast Decision Sciences Institute Proceedings.330-335.

McDonald, M (2007). Technical versus Fundamental Analysis.Equities.55(3)100-100.

Menge, B. A., Daley, B., Wheeler, P. A., and Strub, P. T. 1997.Rocky intertidal oceanography: an association between community structure and nearshore

Phytoplankton concentration. Limnology and Oceanography, 42: 57-66.

Mizrach, B and Weerts, Susan(2009) .Highs and lows: a behavioural and technical analysis. Applied Financial Economics.19(10).767 - 777

Moube A. & Jannach M. (2003). Mutual funds and Stock Selection. Göteborg University, School of Economics and Commercial Laws

Oglesby, D (2003). Fundamental analysis. International Dictionary of Finance(4th ed). 2003.P115-115.

Ozdagli, A (2009). Financial Leverage, Corporate Investment, and Stock Returns. Working Paper Series (Federal Reserve Bank of Boston). 9 (13).1-34

Pereira, B et al (1993). Economic reforms in new democracies. Cambridge: Cambridge University Press.

Standfield, K (2005). Intangible Finance Standards---Advances in Fundamental Analysis and Technical Analysis. Elsevier Inc.

Talati, J(2002).Fundamental vs technical analysis. Retrieved January 04,2010,from http://www.futuresmag.com .January 2002

Toby, A(2007).Financial management modeling of the performance of Nigerian quoted small and medium-sized enterprises. Journal of Financial Management and Analysis.20(l). 49-68

Tomek, W and Querin,S(1984).Random Processes in Prices and Technical Analysis. Journal of Futures Markets.4(1).15-23.

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