Fundamental vs Technical Analysis


When you’re presented with a new opportunity or investment, there are typically two different approaches you can take: a fundamental analysis of the situation, or a technical one. In a previous article we discussed the different types of risk, and now, I’ll teach you how you can analyze those risks in terms of your investments.

What is Fundamental Analysis?

In terms of risk management, a fundamental approach means looking at the “fundamentals” of a particular country, economy, market, business, etc. What this boils down to is the financial statements, and how a given entity manages their finances. We can break this down even further, into two separate categories.

Monetary Policy

On one hand, you have monetary policies: how does this entity manage their money supply? How do they manage and/or set their interest rates? In the United States, the monetary policy is set by the Federal Reserve. When you’re analyzing a country or region, you’ll want to look at the central bank and the monetary policy in place.

Fiscal Policy

On the other hand, you have fiscal policies: how is money spent? Are the spending habits responsible or irresponsible? Does this entity spend more or less money than what they bring in, in taxes?

Combining Monetary and Fiscal Policy

In essence, a fundamental analysis includes financial statements, monetary policy, and fiscal policy. The three of these things together will work to tell you the financial history of an investment. Depending on your investment, you’ll find yourself looking at the fundamentals of a region, a company, or the market itself. Knowing what to analyze is key.

If you go to US Debt Clock you will see, for example, all of the liabilities and assets of the United States. You’ll see how much is collected in taxes. The scary reality is that the US has a pretty reckless history, in terms of spending and the underfunding of liabilities.

In this analysis, another problem becomes clear: we have an aging population. With 76 million aging baby boomers, the social programs in place will experience a lot of pressure. All of this can be gleaned from the financial statements of the US, and shows why a fundamental analysis is a powerful tool.

As it relates to investments, we could perform a fundamental analysis of the stock market. You’d want to ask questions like: Is the market undervalued or overvalued? What is the financial history of the market? Is the market fundamentally sound, or driven more by emotion? Fundamentally speaking, is it a good place to put your money?

The same can be said of certain real estate markets. You must analyze the fundamentals. When looking at real estate opportunities in the rust belt, for example, you must be looking at fundamentals like jobs. Are there enough jobs coming into the area? Is there a diversification of jobs in the region, or is one employer responsible for all of the jobs? If the big employer leaves, the jobs lave with it, and then there’s no one to provide housing for. Being aware of all aspects of a market, and looking at the fundamentals, ensures better strategy.

When you’re investing in a company, their balance sheets are important. You want to know that they’re managing money wisely.

What is Technical Analysis?

While fundamental analysis is based in hard data, technical analysis is based in trends. Let’s say that fundamentally, a specific market is weak. Money isn’t well-managed, or like the stock market right now, maybe it’s overvalued. Behind that specific sector, however, there’s a trend with a lot of momentum that you can capitalize on. So even within a weak market, there could be opportunities.

Technical analysis requires that you look at the reasons behind the trend. What is going on socially, politically, financially, etc that is driving this trend? Why is this trend persisting over another trend? How does one trend play into another?

In real estate, maybe a particular region looks pretty grim for long-term housing, but there’s a lot of momentum toward tourism. You’d have to analyze the trend, as well as the best way to capitalize on the trend. Airbnb, for example, is a popular niche for real estate right now. It’s affordable, and it can provide experiences beyond what a hotel can offer. So it may not be the right time to provide permanent housing, but you could still capitalize on people’s desire for traveling with a more lived-in feel than a hotel.

Understanding trends is about understanding what drives the trend in the first place, so that you can use that trend to your advantage.

Fundamental and Technical Together

Before investing, it’s important to analyze from both a fundamental and technical standpoint. Just because the fundamental analysis doesn’t look great, doesn’t mean there’s a trend that could offer an alternate solution. And just because there’s a popular trend, doesn’t mean it will fundamentally make sense in certain contexts.

Hopefully, this offers insight on how to approach your investments from all angles. Vocabulary, I’ve found, builds bridges to new understanding that I didn’t even anticipate. It continues to shape the way I perceive things. Each niche also has it’s own vocabulary. As Cashflow Ninjas, we should always seek to learn and grow, and continue to study successful folks.

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