Fundamental Analysis

 What Is Fundamental Analysis?

 Understanding FA
 Investing & Fundamental Analysis
 Quant. vs. Qual. Analysis
 Qualitative Fundamentals
 Financial Statements
 The Concept of Intrinsic Value
 Criticisms
 Examples of Fundamental Analysis
 Frequently Asked Questions

What Is Fundamental Analysis?

Fundamental analysis (FA) is a method of measuring a security's intrinsic value by
examining related economic and financial factors. Fundamental analysts study anything
that can affect the security's value, from macroeconomic factors such as the state of the
economy and industry conditions to microeconomic factors like the effectiveness of the
company's management.

The end goal is to arrive at a number that an investor can compare with a security's
current price in order to see whether the security is undervalued or overvalued.

This method of stock analysis is considered to be in contrast to technical analysis, which

forecasts the direction of prices through an analysis of historical market data such as price
and volume.

KEY TAKEAWAYS

 Fundamental analysis is a method of determining a stock's real or "fair market"

value.
 Fundamental analysts search for stocks that are currently trading at prices that are
higher or lower than their real value.
 If the fair market value is higher than the market price, the stock is deemed to be
undervalued and a buy recommendation is given.
 In contrast, technical analysts ignore the fundamentals in favor of studying the
historical price trends of the stock.

Understanding Fundamental Analysis

All stock analysis tries to determine whether a security is correctly valued within the
broader market. Fundamental analysis is usually done from a macro to micro perspective
in order to identify securities that are not correctly priced by the market.

Analysts typically study, in order, the overall state of the economy and then the strength
of the specific industry before concentrating on individual company performance to
arrive at a fair market value for the stock.

Fundamental analysis uses public data to evaluate the value of a stock or any other type
of security. For example, an investor can perform fundamental analysis on a bond's value
by looking at economic factors such as interest rates and the overall state of the economy,
then
studying information about the bond issuer, such as potential changes in its credit rating.

For stocks, fundamental analysis uses revenues, earnings, future growth, return on equity,
profit margins, and other data to determine a company's underlying value and potential
for future growth. All of this data is available in a company's financial statements (more
on that below).

Fundamental analysis is used most often for stocks, but it is useful for evaluating any
security, from a bond to a derivative. If you consider the fundamentals, from the broader
economy to the company details, you are doing fundamental analysis.

Investing and Fundamental Analysis

An analyst works to create a model for determining the estimated value of a company's
share price based on publicly available data. This value is only an estimate, the analyst's
educated opinion, of what the company's share price should be worth compared to the
current market price. Some analysts may refer to their estimated price as the company's
intrinsic value.

If an analyst calculates that the stock's value should be significantly higher than the
stock's current market price, they may publish a buy or overweight rating for the stock.
This acts as a recommendation to investors who follow that analyst. If the analyst
calculates a lower intrinsic value than the current market price, the stock is considered
overvalued and a sell or underweight recommendation is issued.

Investors who follow these recommendations will expect that they can buy stocks with
favorable recommendations because such stocks should have a higher probability of
rising over time. Likewise, stocks with unfavorable ratings are expected to have a higher
probability of falling in price. Such stocks are candidates for being removed from
existing portfolios or added as "short" positions.
This method of stock analysis is considered to be the opposite of technical
analysis, which forecasts the direction of prices through an analysis of historical market
data such as price and volume.

Quantitative and Qualitative Fundamental Analysis

The problem with defining the word fundamentals is that it can cover anything related to
the economic well-being of a company. They obviously include numbers like revenue
and profit, but they can also include anything from a company's market share to the
quality of its management.

The various fundamental factors can be grouped into two categories: quantitative and
qualitative. The financial meaning of these terms isn't much different from their standard
definitions. Here is how a dictionary defines the terms:

 Quantitative – "related to information that can be shown in numbers and

amounts."
 Qualitative – "relating to the nature or standard of something, rather than to its
quantity."

In this context, quantitative fundamentals are hard numbers. They are the measurable
characteristics of a business. That's why the biggest source of quantitative data is
financial statements. Revenue, profit, assets, and more can be measured with great
precision.

The qualitative fundamentals are less tangible. They might include the quality of a
company's key executives, its brand-name recognition, patents, and proprietary
technology.

Neither qualitative nor quantitative analysis is inherently better. Many analysts consider
them together.

Qualitative Fundamentals to Consider

There are four key fundamentals that analysts always consider when regarding a
company. All are qualitative rather than quantitative. They include:

 The business model: What exactly does the company do? This isn't as
straightforward as it seems. If a company's business model is based on selling fast-
food chicken, is it making its money that way? Or is it just coasting on royalty and
franchise fees?
 Competitive advantage: A company's long-term success is driven largely by its
ability to maintain a competitive advantage—and keep it. Powerful competitive
advantages, such as Coca-Cola's brand name and Microsoft's domination of the
personal computer operating system, create a moat around a business allowing it
to keep competitors at bay and enjoy growth and profits. When a company can
 achieve a competitive advantage, its shareholders can be well rewarded for
decades.
 Management: Some believe that management is the most important criterion for
investing in a company. It makes sense: Even the best business model is doomed if
the leaders of the company fail to properly execute the plan. While it's hard for
retail investors to meet and truly evaluate managers, you can look at the corporate
website and check the resumes of the top brass and the board members. How well
did they perform in prior jobs? Have they been unloading a lot of their stock
shares lately?
 Corporate Governance: Corporate governance describes the policies in place
within an organization denoting the relationships and responsibilities between
management, directors, and stakeholders. These policies are defined and
determined in the company charter and its bylaws, along with corporate laws and
regulations. You want to do business with a company that is run ethically, fairly,
transparently, and efficiently. Particularly note whether management respects
shareholder rights and shareholder interests. Make sure their communications to
shareholders are transparent, clear, and understandable. If you don't get it, it's
probably because they don't want you to.

It's also important to consider a company's industry: customer base, market share among
firms, industry-wide growth, competition, regulation, and business cycles. Learning about
how the industry works will give an investor a deeper understanding of a company's
financial health.

Financial Statements: Quantitative Fundamentals to Consider

Financial statements are the medium by which a company discloses information
concerning its financial performance. Followers of fundamental analysis use quantitative
information gleaned from financial statements to make investment decisions. The three
most important financial statements are income statements, balance sheets, and cash flow
statements.

The Balance Sheet

The balance sheet represents a record of a company's assets, liabilities, and equity at a
particular point in time. The balance sheet is named by the fact that a business's financial
structure balances in the following manner:

Assets = Liabilities + Shareholders' Equity

Assets represent the resources that the business owns or controls at a given point in time.
This includes items such as cash, inventory, machinery, and buildings. The other side of
the equation represents the total value of the financing the company has used to acquire
those assets. Financing comes as a result of liabilities or equity. Liabilities represent debt
(which of course must be paid back), while equity represents the total value of money
that the owners have contributed to the business - including retained earnings, which is
the profit made in previous years.
The Income Statement
While the balance sheet takes a snapshot approach in examining a business, the income
statement measures a company's performance over a specific time frame. Technically,
you could have a balance sheet for a month or even a day, but you'll only see public
companies report quarterly and annually.

The income statement presents information about revenues, expenses, and profit that was
generated as a result of the business' operations for that period.

Statement of Cash Flows

The statement of cash flows represents a record of a business' cash inflows and outflows
over a period of time. Typically, a statement of cash flows focuses on the following cash-
related activities:

 Cash from investing (CFI): Cash used for investing in assets, as well as the
proceeds from the sale of other businesses, equipment, or long-term assets
 Cash from financing (CFF): Cash paid or received from the issuing and borrowing
of funds
 Operating Cash Flow (OCF): Cash generated from day-to-day business operations

The cash flow statement is important because it's very difficult for a business to
manipulate its cash situation. There is plenty that aggressive accountants can do to
manipulate earnings, but it's tough to fake cash in the bank. For this reason, some
investors use the cash flow statement as a more conservative measure of a company's
performance.

Fundamental analysis relies on the use of financial ratios drawn from data on corporate
financial statements to make inferences about a company's value and prospects.

The Concept of Intrinsic Value

One of the primary assumptions of fundamental analysis is that the current price from the
stock market often does not fully reflect the value of the company supported by the
publicly available data. A second assumption is that the value reflected from the
company's fundamental data is more likely to be closer to the true value of the stock.

Analysts often refer to this hypothetical true value as the intrinsic value. However, it
should be noted that this usage of the phrase intrinsic value means something different in
stock valuation than what it means in other contexts such as options trading. Option
pricing uses a standard calculation for intrinsic value; however, analysts use various
complex models to arrive at their intrinsic value for a stock. There is not a single,
generally accepted formula for arriving at the intrinsic value of a stock.
For example, say that a company's stock was trading at $20, and after extensive research
on the company, an analyst determines that it ought to be worth $24. Another analyst
does equal research but determines that it ought to be worth $26. Many investors will
consider the average of such estimates and assume that the intrinsic value of the stock
may be near $25. Often investors consider these estimates highly relevant information
because they want to buy stocks that are trading at prices significantly below these
intrinsic values.

This leads to a third major assumption of fundamental analysis: In the long run, the stock
market will reflect the fundamentals. The problem is, nobody knows how long "the long
run" really is. It could be days or years.

This is what fundamental analysis is all about. By focusing on a particular business, an

investor can estimate the intrinsic value of a firm and find opportunities to buy at a
discount. The investment will pay off when the market catches up to the fundamentals.

One of the most famous and successful fundamental analysts is the so-called "Oracle of
Omaha," Warren Buffett, who champions the technique in picking stocks.
Criticisms of Fundamental Analysis
The biggest criticisms of fundamental analysis come primarily from two groups:
proponents of technical analysis and believers of the efficient market hypothesis.

Technical Analysis
Technical analysis is the other primary form of security analysis. Put simply, technical
analysts base their investments (or, more precisely, their trades) solely on the price and
volume movements of stocks. Using charts and other tools, they trade on momentum and
ignore the fundamentals.

One of the basic tenets of technical analysis is that the market discounts everything. All
news about a company is already priced into the stock. Therefore, the stock's price
movements give more insight than the underlying fundamentals of the business itself.

The Efficient Market Hypothesis

Followers of the efficient market hypothesis (EMH), however, are usually in
disagreement with both fundamental and technical analysts.

The efficient market hypothesis contends that it is essentially impossible to beat the
market through either fundamental or technical analysis. Since the market efficiently
prices all stocks on an ongoing basis, any opportunities for excess returns are almost
immediately whittled away by the market's many participants, making it impossible for
anyone to meaningfully outperform the market over the long term.

Examples of Fundamental Analysis

Take the Coca-Cola Company, for example. When examining its stock, an analyst must
look at the stock's annual dividend payout, earnings per share, P/E ratio, and many other
quantitative factors. However, no analysis of Coca-Cola is complete without taking into
account its brand recognition. Anybody can start a company that sells sugar and water,
but few companies are known to billions of people. It's tough to put a finger on exactly
what the Coke brand is worth, but you can be sure that it's an essential ingredient
contributing to the company's ongoing success.

Even the market as a whole can be evaluated using fundamental analysis. For example,
analysts looked at fundamental indicators of the S&P 500 from July 4 to July 8, 2016.
During this time, the S&P rose to 2129.90 after the release of a positive jobs report in the
United States.1 In fact, the market just missed a new record high, coming in just under the
May 2015 high of 2130.82.2 The economic surprise of an additional 287,000 jobs for the
month of June specifically increased the value of the stock market on July 8, 2016.3

However, there are differing views on the market's true value. Some analysts believe the
economy is heading for a bear market, while other analysts believe it will continue as
a bull market.

Frequently Asked Questions

What are the steps in fundamental analysis?
Broadly speaking, fundamental analysis evaluates individual companies by looking at the
firm's financial statements and examining various ratios and other metrics. This is used to
estimate a company's intrinsic value based on its revenues, profit, costs, capital structure,
cash flows, and so forth. Company metrics can then be compared with industry peers and
competitors. Finally, these can be compared to the broader market or larger economic
environment.

Who uses fundamental analysis?

Fundamental analysis is used largely by long-term or value investors to identify well-
priced stocks and those with favorable prospects. Equity analysts will also use
fundamental analysis to generate price targets and recommendations to clients (e.g., buy,
hold, or sell). Corporate managers and financial accountants will also use financial
analysis to analyze and increase a firm's operating efficiency and profitability and to
compare the firm against the competition. Warren Buffett, one of the world's most
renowned value investors, is a promoter of fundamental analysis.

How does fundamental analysis differ from technical analysis?

Technical analysis does not dig under the hood of a company any examine financial
statements or do ratio analyses. Instead, technical traders look to relatively short-term
chart patterns to identify price signals, trends, and reversals. Technical traders tend to
enter into short-term positions and do not necessarily look to longer-term valuation. The
motivation behind technical analysis is largely driven by market psychology.
Does fundamental analysis always work?
No. Like any other investment strategy or technique, fundamental analysis is not always
successful. The fact that fundamentals show a stock to be undervalued does not guarantee
that its shares will rise to intrinsic value any time soon. Things are not so simple. In
reality, real price behavior is influenced by a myriad of factors that may undermine
fundamental analysis.

Investors and analysts will frequently use a combination of fundamental, technical, and
quantitative analyses when evaluating a company’s potential for growth and profitability.

Market Efficiency
What Is Market Efficiency?
Market efficiency refers to the degree to which market prices reflect all available,
relevant information. If markets are efficient, then all information is already incorporated
into prices, and so there is no way to "beat" the market because there are no undervalued
or overvalued securities available.
The term was taken from a paper written in 1970 by economist Eugene Fama, however
Fama himself acknowledges that the term is a bit misleading because no one has a clear
definition of how to perfectly define or precisely measure this thing called market
efficiency. Despite such limitations, the term is used in referring to what Fama is best
known for, the efficient market hypothesis (EMH).

The EMH states that an investor can't outperform the market, and that market anomalies
should not exist because they will immediately be arbitraged away. Fama later won the
Nobel Prize for his efforts. Investors who agree with this theory tend to buy index
funds that track overall market performance and are proponents of passive portfolio
management.

KEY TAKEAWAYS

 Market efficiency refers to how well current prices reflect all available, relevant
information about the actual value of the underlying assets.
 A truly efficient market eliminates the possibility of beating the market, because
any information available to any trader is already incorporated into the market
price.
 As the quality and amount of information increases, the market becomes more
efficient reducing opportunities for arbitrage and above market returns.
At its core, market efficiency is the ability of markets to incorporate information that
provides the maximum amount of opportunities to purchasers and sellers of securities to
effect transactions without increasing transaction costs. Whether or not markets such as
the U.S. stock market are efficient, or to what degree, is a heated topic of debate among
academics and practitioners.

Market Efficiency Explained

There are three degrees of market efficiency. The weak form of market efficiency is that
past price movements are not useful for predicting future prices. If all available, relevant
information is incorporated into current prices, then any information relevant information
that can be gleaned from past prices is already incorporated into current prices. Therefore
future price changes can only be the result of new information becoming available.

Based on this form of the hypothesis, such investing strategies such as momentum or any
technical-analysis based rules used for trading or investing decisions should not be
expected to persistently achieve above normal market returns. Within this form of the
hypothesis there remains the possibility that excess returns might be possible using
fundamental analysis. This point of view has been widely taught in academic finance
studies for decades, though this point of view is no long held so dogmatically.

The semi-strong form of market efficiency assumes that stocks adjust quickly to absorb
new public information so that an investor cannot benefit over and above the market by
trading on that new information. This implies that neither technical analysis nor
fundamental analysis would be reliable strategies to achieve superior returns, because any
information gained through fundamental analysis will already be available and thus
already incorporated into current prices. Only private information unavailable to the
market at large will be useful to gain an advantage in trading, and only to those who
possess the information before the rest of the market does.

The strong form of market efficiency says that market prices reflect all information both
public and private, building on and incorporating the weak form and the semi-strong
form. Given the assumption that stock prices reflect all information (public as well as
private), no investor, including a corporate insider, would be able to profit above the
average investor even if he were privy to new insider information.

Differing Beliefs of an Efficient Market

Investors and academics have a wide range of viewpoints on the actual efficiency of the
market, as reflected in the strong, semi-strong, and weak versions of the EMH. Believers
in strong form efficiency agree with Fama and often consist of passive index investors.
Practitioners of the weak version of the EMH believe active trading can generate
abnormal profits through arbitrage, while semi-strong believers fall somewhere in the
middle.

For example, at the other end of the spectrum from Fama and his followers are the value
investors, who believe stocks can become undervalued, or priced below what they are
worth. Successful value investors make their money by purchasing stocks when they
are undervalued and selling them when their price rises to meet or exceed their intrinsic
worth.

People who do not believe in an efficient market point to the fact that active traders exist.
If there are no opportunities to earn profits that beat the market, then there should be no
incentive to become an active trader. Further, the fees charged by active managers are
seen as proof the EMH is not correct because it stipulates that an efficient market has low
transaction costs.

An Example of an Efficient Market

While there are investors who believe in both sides of the EMH, there is real-world proof
that wider dissemination of financial information affects securities prices and makes a
market more efficient.

For example, the passing of the Sarbanes-Oxley Act of 2002, which required greater
financial transparency for publicly traded companies, saw a decline in equity market
volatility after a company released a quarterly report. It was found that financial
statements were deemed to be more credible, thus making the information more reliable
and generating more confidence in the stated price of a security. There are fewer
surprises, so the reactions to earnings reports are smaller. This change in volatility pattern
shows that the passing of the Sarbanes-Oxley Act and its information requirements made
the market more efficient. This can be considered a confirmation of the EMH in that
increasing the quality and reliability of financial statements is a way of lowering
transaction costs.

Other examples of efficiency arise when perceived market anomalies become widely
known and then subsequently disappear. For instance, it was once the case that when a
stock was added to an index such as the S&P 500 for the first time, there would be a large
boost to that share's price simply because it became part of the index and not because of
any new change in the company's fundamentals. This index effect anomaly became
widely reported and known, and has since largely disappeared as a result. This means that
as information increases, markets become more efficient and anomalies are reduced.

Technical Analysis
 What Is Technical Analysis?

 Understanding Technical Analysis

 Underlying Assumptions of Technical Analysis

 Fundamental Analysis

 Limitations

 Frequently Asked Questions

What Is Technical Analysis?

Technical analysis is a trading discipline employed to evaluate investments and identify
trading opportunities by analyzing statistical trends gathered from trading activity, such
as price movement and volume.

KEY TAKEAWAYS

 Technical analysis is a trading discipline employed to evaluate investments

and identify trading opportunities in price trends and patterns seen on charts.
 Technical analysts believe past trading activity and price changes of a security can
be valuable indicators of the security's future price movements.
 Technical analysis may be contrasted with fundamental analysis, which focuses on
a company's financials rather than historical price patterns or stock trends.

Understanding Technical Analysis

Unlike fundamental analysis, which attempts to evaluate a security's value based on
business results such as sales and earnings, technical analysis focuses on the study of
price and volume. Technical analysis tools are used to scrutinize the ways supply and
demand for a security will affect changes in price, volume and implied volatility.
Technical analysis is often used to generate short-term trading signals from various
charting tools, but can also help improve the evaluation of a security's strength or
weakness relative to the broader market or one of its sectors. This information helps
analysts improve there overall valuation estimate.

Technical analysis can be used on any security with historical trading data. This includes
stocks, futures, commodities, fixed-income, currencies, and other securities. In this
tutorial, we’ll usually analyze stocks in our examples, but keep in mind that these
concepts can be applied to any type of security. In fact, technical analysis is far more
prevalent in commodities and forex markets where traders focus on short-term price
movements.

Technical analysis as we know it today was first introduced by Charles Dow and the Dow
Theory in the late 1800s.1 Several noteworthy researchers including William P. Hamilton,
Robert Rhea, Edson Gould, and John Magee further contributed to Dow Theory concepts
helping to form its basis. In modern day, technical analysis has evolved to included
hundreds of patterns and signals developed through years of research.

Technical analysis operates from the assumption that past trading activity and price
changes of a security can be valuable indicators of the security's future price movements
when paired with appropriate investing or trading rules. Professional analysts often use
technical analysis in conjunction with other forms of research. Retail traders may make
decisions based solely on the price charts of a security and similar statistics, but
practicing equity analysts rarely limit their research to fundamental or technical analysis
alone.
Among professional analysts, the CMT Association supports the largest collection of
chartered or certified analysts using technical analysis professionally around the world.
The association's Chartered Market Technician (CMT) designation can be obtained after
three levels of exams that cover both a broad and deep look at technical analysis tools.
Nearly one third of CMT charter holders are also Certified Financial Analyst (CFA)
charter holders. This demonstrates how well the two disciplines reinforce each other.2

Technical analysis attempts to forecast the price movement of virtually any tradable
instrument that is generally subject to forces of supply and demand, including stocks,
bonds, futures and currency pairs. In fact, some view technical analysis as simply the
study of supply and demand forces as reflected in the market price movements of a
security. Technical analysis most commonly applies to price changes, but some analysts
track numbers other than just price, such as trading volume or open interest figures.

Across the industry there are hundreds of patterns and signals that have been developed
by researchers to support technical analysis trading. Technical analysts have also
developed numerous types of trading systems to help them forecast and trade on price
movements. Some indicators are focused primarily on identifying the current market
trend, including support and resistance areas, while others are focused on determining the
strength of a trend and the likelihood of its continuation. Commonly used technical
indicators and charting patterns include trendlines, channels, moving averages and
momentum indicators.

In general, technical analysts look at the following broad types of indicators:

 Price trends
 Chart patterns
 Volume and momentum indicators
 Oscillators
 Moving averages
 Support and resistance levels

Underlying Assumptions of Technical Analysis

There are two primary methods used to analyze securities and make investment
decisions: fundamental analysis and technical analysis. Fundamental analysis involves
analyzing a company’s financial statements to determine the fair value of the business,
while technical analysis assumes that a security's price already reflects all publicly-
available information and instead focuses on the statistical analysis of price movements.
Technical analysis attempts to understand the market sentiment behind price trends by
looking for patterns and trends rather than analyzing a security's fundamental attributes.

Charles Dow released a series of editorials discussing technical analysis theory. His
writings included two basic assumptions that have continued to form the framework for
technical analysis trading.
 1. Markets are efficient with values representing factors that influence a security's
price, but
2. Even random market price movements appear to move in identifiable patterns and
trends that tend to repeat over time.3

Today the field of technical analysis builds on Dow's work. Professional analysts
typically accept three general assumptions for the discipline:

1. The market discounts everything: Technical analysts believe that everything from
a company's fundamentals to broad market factors to market psychology are
already priced into the stock. This point of view is congruent with the Efficient
Markets Hypothesis (EMH) which assumes a similar conclusion about prices. The
only thing remaining is the analysis of price movements, which technical analysts
view as the product of supply and demand for a particular stock in the market.4
2. Price moves in trends: Technical analysts expect that prices, even in random
market movements, will exhibit trends regardless of the time frame being
observed. In other words, a stock price is more likely to continue a past trend than
move erratically. Most technical trading strategies are based on this assumption.4
3. History tends to repeat itself: Technical analysts believe that history tends to
repeat itself. The repetitive nature of price movements is often attributed to market
psychology, which tends to be very predictable based on emotions like fear or
excitement. Technical analysis uses chart patterns to analyze these emotions and
subsequent market movements to understand trends. While many forms of
technical analysis have been used for more than 100 years, they are still believed
to be relevant because they illustrate patterns in price movements that often repeat
themselves.4

Technical Analysis Vs. Fundamental Analysis

Fundamental analysis and technical analysis, the major schools of thought when it comes
to approaching the markets, are at opposite ends of the spectrum. Both methods are used
for researching and forecasting future trends in stock prices, and like any investment
strategy or philosophy, both have their advocates and adversaries.

Fundamental analysis is a method of evaluating securities by attempting to measure

the intrinsic value of a stock. Fundamental analysts study everything from the overall
economy and industry conditions to the financial condition and management of
companies. Earnings, expenses, assets and liabilities are all important characteristics to
fundamental analysts.

Technical analysis differs from fundamental analysis in that the stock's price and volume
are the only inputs. The core assumption is that all known fundamentals are factored into
price; thus, there is no need to pay close attention to them. Technical analysts do not
attempt to measure a security's intrinsic value, but instead use stock charts to identify
patterns and trends that suggest what a stock will do in the future.
Limitations Of Technical Analysis
Some analysts and academic researchers expect that the EMH demonstrates why they
shouldn't expect any actionable information to be contained in historical price and
volume data. However, by the same reasoning, neither should business fundamentals
provide any actionable information. These points of view are known as the weak form
and semi-strong form of the EMH.

Another criticism of technical analysis is that history does not repeat itself exactly, so
price pattern study is of dubious importance and can be ignored. Prices seem to be better
modeled by assuming a random walk.

A third criticism of technical analysis is that it works in some cases but only because it
constitutes a self-fulfilling prophesy. For example, many technical traders will place
a stop-loss order below the 200-day moving average of a certain company. If a large
number of traders have done so and the stock reaches this price, there will be a large
number of sell orders, which will push the stock down, confirming the movement traders
anticipated.

Then, other traders will see the price decrease and also sell their positions, reinforcing the
strength of the trend. This short-term selling pressure can be considered self-fulfilling,
but it will have little bearing on where the asset's price will be weeks or months from
now. In sum, if enough people use the same signals, they could cause the movement
foretold by the signal, but over the long run this sole group of traders cannot drive price.

Frequently Asked Questions

What Assumptions Do Technical Analysts Make?
Professional technical analysts typically accept three general assumptions for the
discipline. The first is that, similar to the efficient market hypothesis, the market
discounts everything. Second, they expect that prices, even in random market
movements, will exhibit trends regardless of the time frame being observed. Finally, they
believe that history tends to repeat itself. The repetitive nature of price movements is
often attributed to market psychology, which tends to be very predictable based on
emotions like fear or excitement.

What's the Difference Between Fundamental and Technical Analysis?

Fundamental analysis and technical analysis, the major schools of thought when it comes
to approaching the markets, are at opposite ends of the spectrum. Fundamental analysis is
a method of evaluating securities by attempting to measure the intrinsic value of a stock.
The core assumption of technical analysis is that all known fundamentals are factored
into price; thus, there is no need to pay close attention to them. Technical analysts do not
attempt to measure a security's intrinsic value, but instead use stock charts to identify
patterns and trends that might suggest what the security will do in the future.

How Is Technical Analysis Used?

Technical analysis attempts to forecast the price movement of virtually any tradable
instrument that is generally subject to forces of supply and demand, including stocks,
bonds, futures and currency pairs. Across the industry there are hundreds of patterns and
signals that have been developed by researchers to support technical analysis trading.
Technical analysts have also developed numerous types of trading systems to help them
forecast and trade on price movements.