If you want to invest in the stock market, you can use two different analysis methods. On the one hand, there is the Chart analysiswhich is often referred to as technical analysis. And then there is fundamental analysis. The former focuses primarily on the price in a price chart of securities, while the latter pays particular attention to key figures such as profit and growth.
The most important in a nutshell
- Chart analysis uses price movements to draw conclusions about how the price might move in the future
- Fundamental analysis looks at a company's key figures to decide whether the share price is undervalued or overvalued
- Short-term trading is primarily based on technical analysis, while long-term investing is primarily based on fundamental analysis
- Both methods can also be combined in a hybrid approach, whereby fundamental analysis is used for stock selection and technical analysis for timing entries
What is chart analysis?
Technical chart analysis (price action) uses price movements to predict with a certain probability how a price will move in the future. There is no technical object that is always 100% right! The sole aim is to answer the question "Is it more likely that the price will rise or fall?"
The analysis itself is implemented in stock charts, whereby the line chart and the candlestick chart are used in particular. Chart analysis primarily uses trends, Chart formations and indicators to give hints as to where the price might be heading.
Chart analysis distinguishes between upward, downward and sideways trends, whereby the probability of a trend continuation is always higher than the probability of a trend reversal. So if a price chart is in an upward trend, it makes more sense to bet on prices continuing to rise. In practice, this principle is also referred to as trend trading and is equally applicable to all shares, indices, forex, cryptos, etc.
With the Trend analysis The main focus is on the highs and lows in a security's price chart. A series of higher highs and higher lows is defined as an upward trend, whereas a series of lower highs and lower lows is referred to as a downward trend. If the price has equal highs and lows, this is a sideways trend.
With chart formations, a distinction is made between continuation and reversal formations. The patterns resemble objects from the real world, such as a triangle or a flag. The best chart pattern for continuation is a flag formation, whereas the best pattern for a reversal is the shoulder-head-shoulder formation. Recognizing such a formation in the chart is always a good indication of whether a trend will actually continue or whether it is close to the end and will soon be reversed.
Trading indicators are mathematical formulas that automatically evaluate the price trend. Here too, a decision is made between continuation and reversal indicators, with the best-known indicators being the MACD and the RSI indicator. Trading indicators offer good orientation in the market for beginners. Indicators are less popular with advanced traders as they are time-delayed and provide delayed signals.
In practice, it makes sense to combine several charting tools in order to create a meaningful forecast. My recommendation is to select two or three of them. For example, you could first analyze the chart for a trend and then use an indicator or chart formation to select an entry point. The chart technique can also be used to create a meaningful Stop loss and a Take profit order define which risk management measures are included in trading.
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What is fundamental analysis?
Fundamental analysis is a valuation method for shares in which the economic activities of a company are analyzed. The main aim is to answer the question of whether a company has been able to operate profitably in the past and whether the business model will continue to be viable in the future. Not only are the company's key figures analyzed, but also the competitive situation, the industry, the company management, etc.
The aim of the analysis is to determine the "real" value of the company and compare this with the currently traded market value. An attractive buying opportunity arises if the specially calculated value is higher than the current stock market value. For example, the real value of the share could be €100, while the market price is €70. In this case, we speak of an undervalued share with potential returns. If, on the other hand, the intrinsic value of the share is below the current market price, this is referred to as an overvalued share, which is why it makes sense to sell.
A popular method is the discounted cash flow (DCF) method. Here, the current value of the company is calculated on the basis of future cash flows, which are discounted to the present day. As the DCF model only makes assumptions about future income, there are a number of other methods for valuing the company, such as the market value or net asset value method.
In addition to calculating future values, it is also interesting to analyze current key figures. For example, the equity ratio can be an indication of how financially stable or crisis-proof the company is. A company key figure is also often set in relation to the share price. If, for example, the share price is set in relation to the cash flow, the result is the price/cash flow ratio (KCV).
Similar to the KCV, there is also the Price-earnings ratio (P/E ratio)the price/sales ratio (P/S ratio) and the price/book ratio (P/B ratio). The P/E ratio puts the current share price in relation to the annual earnings per share. A low P/E ratio can indicate an undervalued share - especially if the company generates stable profits. A high P/E ratio, on the other hand, indicates that investors believe the company will grow strongly in the future. In such cases, you are already paying "a lot" for expected profits.
The KUV compares the share price with the turnover per share. The KUV is particularly helpful for companies without high profits in growth sectors. The lower the KUV, the more favorable the share price appears in relation to the turnover generated. However, this does not automatically mean that the company is or will be profitable.
The P/B ratio (price-to-book ratio) compares the share price with the company's book value per share. The book value is what would remain in purely mathematical terms if the company were liquidated today - i.e. assets minus liabilities. A P/B ratio below 1 means that the share is trading below the net asset value of the company, i.e. it is undervalued. A high P/B ratio, on the other hand, can mean that investors believe the company is capable of strong growth.
Such a calculated ratio is not very meaningful on its own, which is why it should be considered in both a historical and industry comparison! For example, a company may have always had a P/E ratio of 40 in recent years, which is why a current value of 25 offers an opportunity. On the other hand, three companies from one sector could have a P/E ratio of 40 and another company of 60, meaning that the last company is valued as significantly more expensive than the other three.
Similarities & differences at a glance
Chart analysis and fundamental analysis are two fundamentally different methods for making decisions on the stock market. The most important difference lies in the data basis: while chart analysis is based purely on price movements, price patterns and trading volumes, fundamental analysis is based on key company figures, balance sheets and economic data. Technical analysis therefore looks exclusively at the behavior of the market, while fundamental analysis evaluates the internal state of a company.
The aim of the two methods also differs significantly. Chart analysis attempts to derive probabilities for future developments from past price movements, i.e. when and where to buy/sell. Fundamental analysis, on the other hand, looks for the answer to the question of what to buy - namely companies whose current share price is below the estimated intrinsic value.
Another important difference is the subjectivity of the application. Chart analysis is often dependent on interpretation: Two traders can look at the same chart and still come to different conclusions, especially in the case of formations or trend lines. Fundamental analysis, on the other hand, appears more objective at first glance as it is based on figures. However, assumptions, forecasts and valuations also play a major role here, for example when calculating future cash flows in the DCF model.
Despite the many differences, both analysis methods pursue the same goal: to help investors make well-founded investment decisions. In addition, both methods are based on assumptions about the future. Chart analysis assumes that trends and patterns will occur with a certain probability, while fundamental analysis assumes that a company will reach certain benchmarks.
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Which method is better?
There is no general answer as to whether chart analysis or fundamental analysis is better. Rather, it depends on the individual situation of the investor. As a short-term trader, it makes more sense to use technical analysis, whereas as a long-term investor, both chart analysis and fundamental analysis are very helpful. The fact that fundamental analysis is hardly applicable in the short term is mainly due to the fact that the data is typically only reported on a quarterly basis.
It is important to note that the two procedures are not mutually exclusive! Especially in long-term analyses, as well as in extreme market situations such as crashes, it makes sense to pay attention to both fundamental data and technical signals. After all, the two approaches are also linked, as the example of calculating the P/E ratio illustrates. A change in the share price has a direct impact on the ratio.
If you want to use a so-called "mixed approach", where both methods are applied, fundamental analysis can help with stock selection and technical analysis with finding good entry points. Chart analysis helps with better timing of entries and exits.
Conclusion: Many paths lead to success
Whether chart analysis or fundamental analysis - both approaches have their strengths and weaknesses. If you want to trade in the short term and need to make quick decisions, technical analysis is a useful tool. On the other hand, those who want to invest for the long term and understand the intrinsic value of a company should look at fundamental analysis. Ultimately, no investor has to commit to just one method, but can skillfully combine both approaches.
Chart analysis is highly visual and can be learned by regularly practicing directly on the chart. If you look at a lot of charts, recognize patterns and follow price movements, you will develop a better and better feeling for trends, formations and price behaviour over time. Fundamental analysis, on the other hand, requires a basic understanding of economics. Knowledge of macroeconomics (e.g. interest rates, inflation, economic growth) and microeconomics (e.g. corporate structures, competition analysis, balance sheet ratios) is essential in order to be able to correctly classify and evaluate business models.
