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Tuesday 15 February 2011

Fundamentalists Vs Chartists: Stick to your knitting

There are fierce debates on the efficacy of both technical and fundamental analysis. "Fundamentalists" snigger at "chartists" with comments such as "I have never seen a rich technical analyst in my life" or "How can one look at squiggles on charts to understand the valuation of a company". Chartists on the other hand say that fundamentalists have no idea of market movements and often change their BUY/SELL call too late (after the maximum damage is done in case of a fall in prices).

Let us take a quick look at what these two lines of analysis are. Fundamental analysis is looking at the company's published financial results, understanding its business model, competitive environment, economic headwind and tailwinds to ascertain a fair value for its publicly traded shares. This type is further sub-divided into two major categories - bottom-up and top-down analysts. Bottom-up analysts are those who look at the company's details and then decide on whether to invest or not. Top-down analysts, on the other hand, are those who start by analyzing  the economy, sectors supposed to perform well and from their drill down on good companies to invest in.

Extraordinary proponents of fundamental analysis are Warren Buffet, Peter Lynch, Walter Schloss, Phil Fisher, David Dremen and Seth Klarman among others.

Technical Analysis is when analysts look at the charts of price and volume of a stock of a security and try to establish a pattern. Their belief is that all news and views are already discounted in the stock price. So, just by studying price patterns (along with their volumes) effective predictions can be made of future prices. It is comparatively more difficult to find really famous and successful technical analysts. It is important to realize that all successful speculators are/were not technical analysts (this is a common misconception that many have - that all traders/speculators follow technical analysis, which is definitely not the case).

I am probably more of a "fundamentalist" than a chartist, but that is probably because of lack of expertise in the latter field. The issue is that both technical and fundamental analysis try to predict the future through varying means. And, at times, both will be wrong. It is very important to realize this and to learn one or the other (or both) forms of analysis. Use what works best for you. Whatever analysis you use, make sure its your own. That way you will have conviction and is the only way to make sustainable wealth in the markets.

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