Technical Analysis & Fundamental Analysis

As previously stated, TA believes the market discounts all available information before such information is fully observable in the market, and prices move in trends which are forecastable via certain methods. However, FA dismisses most of TA and is instead rooted in the economics of supply and demand and its deterministic factors. The difference

between TA and FA is stated by Murphy (2012, p5): ‘’the fundamentalist studies the cause

of market movement, while the technician studies the effect’’. FA is a method of valuing a security which entails measuring its fair value by examining relevant economic and financial factors. Economic factors are deemed to be either micro or macroeconomic factors relevant to the security. Financial factors are deemed to be firm-specific, for example, the firm’s business ratios, projected earnings, and tax rates. The purpose of performing FA is to establish a fair value that an investor can compare with the security's

29

current market price to determine whether to buy or sell the security. A rational investor applying FA would buy a security if its current price is below its fair value and sell a security if its current price is above its fair value. A famous and successful proponent of FA is billionaire investor Warren Buffett, who is well known for his use of FA in selecting securities.

Historically, throughout academia, published literature, and industry existed the near constant division between TA and FA. TA was met with disdain by academics largely due to its conflict with the Efficient Market Hypothesis (EMH), although it has now been generally accepted. In industry, traders and investors typically describe themselves as either technical or fundamental with some describing themselves as both. The reality is both forms of analysis complement one another, and the categorisation should not be fundamental or technical but fundamental and technical because either form of analysis used in isolation is depriving the market participant of potentially valuable information. Furthermore, regarding Graham & Dodd’s 1934 book Security Analysis which laid the foundations of FA, a close reading of their text reveals that Graham nor Dodd did not believe that FA alone determined stock prices: ‘’The influence of what we call analytical

factors over the market price is both partial and indirect – partial, because it frequently competes with purely speculative factors which influence the price in the opposite direction; and indirect, because it acts through the intermediary of people’s sentiments and decisions.’’ (Graham & Dodd 1934, p28). Pertaining to this view is Goodhart (1988) who argues that exchange rates are determined by a balance of technical and

fundamentalist prediction: ‘’The interplay between speculation based on fundamentals,

and on a random walk, or Chartist, approach, influences the outcome’’. Evidently, no form of analysis used in isolation is wholly capable of supplying the market participant with a complete information set. FA does not define trend, nor the belief in them, therefore does not subscribe to technical characteristics such as; levels of support and resistance, consolidation zones, trend channels, price targets or breakouts, despite such characteristics being abundantly evident in the chart of any security. Likewise, from a TA perspective little is said or implemented regarding FA. Although, Technical Analysts believe that fundamentals are inherent, or built-in, to a security’s chart, therefore by applying TA they are indirectly and simultaneously employing FA.

30

Since FA is a product of individual estimates of economic and firm-specific factors, FA is not free from subjective-emotion and error on the part of the analyst. Therefore,

proponents of FA could not only suffer losses from an incorrect estimation of fair value but also suffer losses from a correct estimation superseded by a counter market movement induced by mass market participants. In contrast, TA acts passively and only responds to its instruments which conform to the expectations of mass market participants. Proponents of FA also criticise TA and its subsection of Chartism because of its subjective nature and the fact it is based on a framework of patterns and trends renders it impossible to

standardise the observations. Murphy (1999) affirms the subjectivity of Chartism, admitting that sometimes disagreement even regarding simple patterns exists. However, regarding technical indicators, such arguments are anchorless because definitive signals create an objective trading approach. As a result, technical indicator-based trading strategies can be implemented more efficiently than FA. While it is true that FA’s evaluation of relevant internal and external company data can produce illuminating

information as to the future development of a firm, it does not completely explain reactions to the company’s share price on stock exchanges. Conversely, TA integrates the

psychology of market participants, therefore at least partly accounts for such reactions. Ultimately, the critical question is whether forecasting, be it technical or fundamental, is profitable at all - or if an investor should spare themselves the analytic cost and apply the Buy & Hold strategy as advocated by the EMH.