Identifying the factors important in explaining movements in equity prices has long been a focus of the research. The research is divisible into two largely distinct and often competing methods of analysis. These are fundamental analysis and technical analysis. Proponent s of each type of analysis have agreed on the general nature of factors responsible for identifying particular variables which are relevant in predicting the course of stock price movements. Technical analysis involves studying the effect of various trading rules to enable investors to earn superior profits. The past researches support the role of technical analysis in predicting future share performance. However, empirical evidence suggests that investors and analysts might follow different practices in different stock markets for predicting stock price movements. Thus, the practice of predicting stock price movements in an emerging market may be different from that followed in other developed markets. For example, in the United States, financial newspapers carry reports on the stock market performance, and the reports mainly use fundamental analysis. A body of research developed during the past focused on the use of fundamental and technical analysis. Nonetheless, studies comparing the use of both these analyses are less. In this context, the current study seeks to explore how fundamental and technical analyses help investors and professionals in taking decisions to sell or buy financial assets. Comparison of the salient features of both the analytical methods is the central focus of this study. This research is expected to add to the existing body of knowledge on fundamental and technical analysis of stock price movements.
Individual investors registered with share broking companies and brokers will be the participants of the proposed survey. I will use a random sampling method to choose the samples for the survey. The survey will be conducted as an online survey by sending the questionnaire by email to the selected samples. The email ids of the samples will be collected from the database of the investment and share broking companies. In total, the research proposes to send the questionnaire to 220 samples.
The purpose of the study is twofold: first, the completion of a cycle took place with respect to the stock markets all over the world, because of the general economic downturn. Every stock has lost their sheen and market fancy and faced the reality of the situation. Once again, the need for ‘value investing’ has emerged in the wake of care the investors have to take while considering any investment in the stock market. Fund managers and investors have started looking at stocks of companies functioning in traditional sectors and they want to adopt customary accounting-variables-based models for the valuation of their potential investible stocks. This has necessitated a revisit to the traditional stock valuation models. Second, the review of the relevant literature highlights the paucity of research work on the use of extensive technical analysis of stock performance. Most of the past work based on the P/E valuation model has considered data from the US stock markets. Therefore, this study seeks to assess the relative role and utility of fundamental and technical analysis in assessing stock performance. The purpose of the study is to compare both fundamental and technical analyses and their effectiveness in predicting stock performance.
Based on professional and efficient guidance from our professor and with enough time to conduct the research, I believe I can complete this research and submit the dissertation in time. I am sure there is adequate availability of research materials, and strong motivation to do a very interesting and timely topic of fundamental and technical analysis. Source information is not too difficult to find because of several factors working to my advantage such as the availability of diversified information from the universe of information that the internet can provide, periodicals like newspaper, magazines and books. Professional journals will help in providing adequate background information on the topic. Secondly, the topic I have chosen interests a number of people from all walks of life, particularly individual investors, financial analysts, economists and scholars who might have different views about the topic. Finally, because there is a large volume of prior research done on the topic, an adequate amount of information has been circulating and documented by respectable scholars in the field, which will guide me through the research.
Aims and Objectives
The central aim of the study is to compare the role and utility of fundamental and technical analysis of stock performance. In the process of achieving this central aim, the study assists in achieving the following objectives
- To study the factors affecting the investment decisions pertaining to stock market investments of investors
- To study the features, role and utility of fundamental and technical analyses of stock performance
- To study the importance of information and analysis in the investment decisions of the investors
Research designs are plans and the procedures for research that span the decisions from broad assumptions to detailed methods of data collection and analysis (Cresswell, 2009). The current research has used a mixed research method, which combines quantitative and qualitative methods, techniques or, other paradigm characteristics in conducting the study. Mixed Research combines the advantages both qualitative and quantitative techniques. Qualitative research involves emerging questions and procedures, data analysis. On the other hand, quantitative techniques involve analyzing numerical data. While using mixed method the researcher combines both qualitative and quantitative research approaches within a phase of the study or across two of the phases or stages of the research process. The study will engage a quantitative survey using the survey instrument of questionnaire composed of multiple open-ended questions, combined with qualitative interviews with some of the participants.
For the purpose of the current research, the terms “fundamental analysis” and “technical analysis” are defined as below.
“Analysis of security values grounded in basic factors such as earnings, balance sheet variables, and management quality. Fundamental analysis attempts to determine the true value of a security, and, if the market price of the stock deviates from this value, to take advantage of the difference by acquiring or selling the stock. Fundamental analysis may involve investigating a firm’s financial statements, visiting its managers, or examining how a particular industry is affected by changes in the economy,” (Scott, 2003).
“The study of relationships among security market variables such as price levels, trading volume, and price movements, so as to gain insights into the supply and demand for securities. Rather than concentrating on earnings, the economic outlook, and other business-related factors that influence a security’s value, technical analysis attempts to determine the market forces at work on a certain security or on the securities market as a whole,” (Scott, 2003).
Thus, while fundamental analysis considers the economic and market environment and their impact on the share price movements for assessing the performance of stocks, technical analysis considers the historical performance of the specific stock.
While selecting the securities it is the normal practice of the investors to follow an active stance, which gives them an opportunity to select those securities maximizing the return with minimum of risk involved. The investors generally do a fundamental analysis and/or technical analysis for selecting the stock. Yield to maturity, term to maturity, credit rating, tax advantages, and liquidity of the stock are some of the factors that influence the decision of the investor in securities selection.
The traders in stock market futures generally take their positions based on an analysis of the possible cause and effects of certain factors on the stock prices. The analysis may take two different forms namely the fundamental analysis and the technical analysis. While the fundamental analysis concentrate on the effect of causes external to the trading in the stock markets the technical analysis involve a study of the historical price movements of different stocks to determine the possible course of future stock market prices. The fundamental analysis mainly takes in to account the likely economic impact on the share price movements. The fundamental analysis includes among other things, the analysis of weather conditions, current inventory levels, government policies, economic indicators, trade balances, and the likely reaction of the traders for economic events and shocks. Thus, the fundamental analysis takes into account mainly how the economy would affect the stock price movements by the changes in its various facets. The supply and demand position of goods and services, the agricultural fundamentals, and the live stock fundamentals are some of the factors the fundamental analyst takes into account in arriving at the future changes in the stock market situation, which in turn depends largely on the economic conditions prevailing in the country.
Thus, analysis of stock market performance generally takes the form of a fundamental analysis or technical analysis. Both analytical methods are different approaches to the decision-making process of people investing or trading in stocks and securities market. Broadly this process concerns the selection of markets and securities, in which the investor could block his investible funds, and it deals with the timing for opening and closing of trades or investments so that the investor would be able to maximize his returns.
Need for Information for Stock Market Analysis
The availability of adequate and proper information on the various securities that are dealt with in the market often influences the stock market movements. Based on market data, the share prices fluctuate and such changes represent the sentiment of the market. In an efficient market circumstance, because the share prices depend on the existing information, changes in the share prices will occur only when there is different information obtained on the shares. The relative validity of the information largely decide the changes in share prices, and the extent to which such information affects the earnings and growth of the company of whose shares are currently traded. In the same manner as to how it is not possible to expect the information to flow, it is impossible to judge the course of the share prices, which are bound to move depending on the receipt of new information. Generally, not every individuals dealing in securities need have full knowledge on the shares nor is it expected that all of them have the capability to understand and utilize the data and information for making economic gains from the market. The only requirement of efficient market is that some of the individuals dealing in shares possess the capability to perceive and analyze information and depending on the knowledge of these individuals, the complete traders will get valid information. Thus, the efficiency of the market is determined purely based on the availability of the information. Analysts use the available information to make a technical or fundamental analysis of the performance of different stocks.
Overview of Fundamental and Technical Analysis
Fundamental analysis as defined earlier, is a method by which the investor would be able to evaluate the performance of a stock, with the objective of measuring the intrinsic value of the stock. The investor can undertake fundamental analysis by an examination of the related economic, financial, and other available qualitative and quantitative factors pertaining to the stock market as a whole as well as those pertaining to the individual stock. The purpose of fundamental analysis is to study all the elements that could influence the value of the security including macroeconomic factors such as the overall economic and prevailing industry conditions. The analysis takes into account the specific factors affecting the value of the individual stock, while assessing the stock performance. The goal of fundamental analysis is to find a value that an investor could compare with the current price of an underlying asset, and this value could guide the investor as to the position, he needs to take with respect to a particular stock. The investor may decide to buy if from the fundamental analysis, the stock has an under-pricing, or alternatively he may decide to sell the stock, if the fundamental analysis showed that the stock is overpriced.
Technical analysis is a technique, the investor uses to evaluate the performance of a stock, by using the statistics and historical trends created by market activity. The statistics may cover many aspects relating to the trading in the respective securities, such as price and volume. The purpose of technical analysis is not to measure the intrinsic value of a security; but the technique uses charts and other analytical tools to establish a pattern, which could suggest the investor the likely future course of the movement of prices and return from a specific stock. Three important assumptions underlie the process of technical analysis. They are: (i) the market will discount all the factors affecting the stock performance, (ii) stock prices exhibit particular trends and (iii) history tends to repeat itself.
Literature Review on Technical Analysis
Late 1800s witnessed the origin of technical analysis, beginning with Charles Dow. Dow indicator was the first technical analysis indicator used in assessing stock performance. Many analysts and practitioners consider Charles Dow as the father of technical analysis, who is the founder of Dow Jones and Company, the publisher of Wall Street journal. During the1900s, Charles Dow published a series of papers, which described the ways in which the prices of the Dow Jones Industrial Average and the Dow Jones Transportation Index moved. Based on the analysis of the indices, he has done, Dow made public his beliefs that markets have a tendency to move in similar patterns over time. The thoughts expressed in the papers by Dow were expanded by others in the later years acquired a common name of “Dow Theory.” Despite the fact the Dow Theory, contextualized the circumstances prevailed over 100 years ago, the observations of the theory are relevant even until today. Although, Dow focused mainly on stock indices in his works, the basic principles apply equally to all the markets.
Brown and Jennings (1989) showed that technical analysis is of significance in a model, in which there is no transparency of the prices. The technique also applies in cases where traders have rational conjectures concerning the nexus between stock prices and signals. Frankel and Froot (1990) observed an increasing importance of chartists in the overall analysis of stock market performance. Although “Neftci (1991) showed that a few of the rules used in technical analysis generate well-defined techniques of forecasting, but even well-defined rules were shown to be useless in prediction if the economic time series is Gaussian” (Sewell, 2007). However, in cases where the stock movement trends do not follow a regular pattern, then the analysis might be able to gather and provide some relevant data for decision-making. According to subsequent tests, moving averages might follow the same course. Results of a survey conducted by Taylor and Allen (1992) among foreign exchange dealers, reported that 90 percent of the participants had a leaning toward technical analysis. Analysis during shorter time horizons use technical data and information rather than depending on fundamental analysis.
“In a comprehensive and influential study Brock, Lakonishok and LeBaron (1992) analysed 26 technical trading rules using 90 years of daily stock prices from the Dow Jones Industrial Average up to 1987 and found that they all outperformed the market,” (Sewell, 2007). Blume, Easely and O’Hara (1994) found that volume of trade could provide information quality, which the price movements were unable to provide. Their study showed that investors and brokers who were trading on stocks relying on data retrieved from historical stock exchange figures were able to have a better control on their earnings and profits than those who did not use such statistical information. Study by Lui and Mole (1998) on the use of the two analytical methods by trading houses engaged in foreign exchange transactions in Hong Kong reported that more than 85% of the respondents relied on both fundamental and technical analysis and most of them used technical analysis for their decision-making over short-term horizons.
LeBaron (1999) studied the use of technical analysis in the foreign exchange market. The study found that after removing periods of active intervention by the Federal Reserve use of technical analysis led to dramatic reduction in exchange rate predictability. Lo, Mamaysky and Wang (2000) examined the effectiveness of the use of technical analysis on U.S. stocks. The study covered the period from 1962 to 1966 and found during the sample period, many of the technical indicators used in the analysis provided incremental information of significant quality and such information had practical value to help in the decision-making.
Review of Literature on Fundamental Analysis
The history of fundamental analysis as a trading mechanism started with the use of it by Benjamin Graham. He published his book Security Analysis in 1934, which provided the definition for the framework of Value Investment. Since the time of Graham, a large volume of research focused on the use of fundamental analysis for assessing the performance of securities and their price movements. Basu (1977)’s study covered the relationship between P/E ratios and excess returns and this study was the first to uncover the evidence, which was against the operation of efficient market hypothesis (EMH). “Basu concluded that there was an information content present in publically available P/E ratios, and portfolios built from low P/E stocks earned excess returns even after adjusting for risk.” Study by Banz (1981) confirmed the association between market capitalization of a firm and its returns, even after adjusting the risk. This study was based on the size effect on the firm’s returns. Further studies confirmed that data on firm size would help in creating portfolios capable of earning excess returns. Rosenberg et al (1984) discovered further fundamental anomalies such as book-to-market effect. This study found that stocks having high book-to-market value could yield higher long-term returns. Fama and French (1992) further examined the anomalies and concluded that ratio of book-to-market value and firm size must be proxies for risk-exposure, when the asset pricing is rational. Lakonishok et al (1994) find that several factors related to the business of companies like sales increase, book value of assets as compared to market value of shares, operating cash inflows and profits will lead to higher earnings from shares. The authors therefore, argued that the stand by Fama and French (1995) in this respect that these values are riskier as wrong.
In 1995, study by Fama and French (1995) provided the response to Lakonishok et al. by pointing out that book-to-market and firm size are, “proxies for sensitivity to risk factors in returns.” Their study identified a size factor in the fundamentals that could lead to a size-related factor in the stock returns and this factor could help in assessing the stock performance. Study by Piotroski (2000) was important in that it focused on high book to market securities. The study showed that the average earnings by a trader who invests in shares having high “book-to-market” ratio could go up by a minimum of 7.5% on a yearly basis. The study by Piotroski (2000) covered several fundamental ratios and criteria having similar outcomes. Piotroski (2000) noted, “Returns are concentrated in small and medium size companies, companies with low share turnover, and firms with low analyst following.”
Efficient Stock Market on the Securities Trading
“An ‘efficient’ market is defined as a market where there are large numbers of rational, profit-maximizers actively competing, with each trying to predict future market values of individual securities, and where important current information is almost freely available to all participants” (Fama 1995).
“In an efficient market, competition among the many intelligent participants leads to a situation where, at any point in time, actual prices of individual securities already reflect the effects of information based both on events that have already occurred and on events, which, as of now, the market expects to take place in the future. In other words, in an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic value,” (Fama 1995).
As stated above, according to the Efficient Market Hypothesis, at any particular point, the prices of stocks traded in an exchange will fully echo all existing information. The “Efficient Market Hypothesis” implies that the while trade in shares, they do so on the expectation that the worth of the shares are more than what they pay at the time they are buying and the value is less than the sale price at the point they sell the shares. However, “But if markets are efficient and current prices fully reflect all information, then buying and selling securities in an attempt to outperform the market will effectively be a game of chance rather than skill” (Greekshares.com). This situation arises because a number of other elements acting on the stock prices influence the changes in the prices in different directions based on their optimistic or pessimistic impact on the sentiments of the individuals investing and trading in shares.
“Random Walk Theory,” which suggests that the changes in share prices do not pursue any trend that enables prediction of the changes. According to the theory changes in the share prices that took place in the past will not help to gauge the changes in the share prices for the future.
With the increase in the number of individuals, having extensive knowledge in dealing with securities, irrespective of whether they are over-priced or under-priced, the market is more likely to turn into an efficient one. In that situation, the market will be able to distribute information quickly and efficiently. The market will be able to collect information from more number of participants making the quality of information improve higher. Efficient Market Hypothesis provides a general outline of the likely changes in share prices. On the other hand, technical indicators-based techniques have worked to adopt some sophisticated analytical methods to estimate the likely changes in share prices.
The competence in dealing with securities has its own repercussions on the buying and selling of shares both from the purview of the individuals investing in securities and the shares of firm being dealt. Generally, information available in public domain might not help in earning superior level of profits. Therefore, it is necessary that an individual investor must stick to a portfolio, which costs minimum to trade. He has t monitor his dealings relying on as much valuable information as can be retrieved at an appropriate time to derive the benefits of the market, which functions efficiently. The force of the investing public, governmental regulations, and exchange legislations must support the information flow from the firms, so that the market reactions can be sharp and the shares would be priced appropriately. This information will form the basis for investors making a technical analysis or a fundamental analysis depending on the nature of information.
Manipulation or withholding of information by firms is most likely to affect the market efficiency largely. Such acts of companies will have significant impact on their share prices. When the firms have their short-term economic gains as the goal and manipulate the information, such actions of the firms will affect the interests of both the firms as well as the investors. The reason for such undesirable consequence is that, when the stock market dealings are carried on based on unreliable and false information, the shares would be priced incorrectly. This will lead to loss of wealth of individual investors who bought and sold shares of such companies. Here the use of technical analysis comes into play for unearthing the true position of the firms, as a fundamental analysis based on published information may not be able to bring to light the intricacies involved in the information withheld by the firm. Technical analysis using statistical and other tools can provide immense help to the investor to know the potential of the stock to earn or to appreciate in the near future.
Deficiencies of stock markets found by researchers do not conform to the principles of efficient market hypothesis. These formed the basis for the development of fundamental analysis. Fundamental analysis helps the analysts and investors to take advantage of the presence of anomalies in the market to maximize their returns. Thus, the purpose of fundamental analysis is to highlight the effect of market anomalies on stock price movements. The common inference is that when a deficiency in the stock market operation is discovered, traders and investors seek to take advantage of the deficiency and thereby would try to increase their economic gains. This will lead to the disappearance of the deficiency in the future. Numerous anomalies discovered, and documented disappeared from the market or firms could not exploit them because of high transaction costs.
It is a debatable question as to whether to use technical or Fundamental analysis in investment decision-making. Large volume of literature focused on several methods to estimate the likely changes in share prices. Most of them recommended the use of both fundamental analysis and technical analysis depending on the time horizon and nature of securities. Several other considerations weigh with the selection of any one-analysis method. Investors who would like to use fundamental analysis may have to take into account the impact of different economic conditions, financial impact, and ratio of share price to dividends declared by the firms in respect of the stocks of which are in question. This information will enable the investor to ascertain the reasons as to why a stock will move. On the other hand, the objective of technical analysis is to present information on how and when a stock will move. Technical analysis does not take into account the data on the stock price movements. Essentially the analysis depends on historical information presented by way of charts. One is at liberty to engage a combination of both technical and fundamental analysis, if the circumstances so warrant. The implication of this situation is that when the shares, under analysis tend to be attributed undervalue based on its fundamental values, the investor would prefer to consider the recommendations of a technical analysis to take the decision to trade in the particular shares. It is the opinion of an individual that gives a decision to use the appropriate method to earn greater returns. However, the objective of both the analysis methods is to gauge the market direction. One can be a successful investor just by using any one of the analytical methods and earn substantial profits.
The viewpoints of both schools of thought are different. For the analysts or traders, who follow the fundamental analysis, charts are a waste of time. Fundamental analysts are of the opinion that using charts may not be able to provide any factual recommendations to the investor, because charts base the analysis on technical indicators and on the consideration of patterns in share price movements. The fundamental analysts are essentially bargain hunters. These people decide to invest in shares, which according to them are undervalued and they believe that these stocks will reach their value in the course of time. This belief makes them to keep the shares in their portfolio for long-term as compared to those who depend on technical analysis.
On the other hand, individuals who follow technical analysts are of the opinion that numbers can always present a true picture and that information based on value, supply and demand will have significant influence on the stock price movements. According to technical analysts, the behaviors of investors follow a conventional model and that such patterns will represent these behaviors. Technical analysts believe that there can be an estimation of these patterns and therefore, such patterns will help in forecasting future changes in share prices. Investors who follow technical analysis generally tend to keep the shares for short-term as compared to those who follow fundamental analysis.
It is evident that both avenues are important in assessing stock performance and predicting possible stock price movements. It is important that one must take careful decisions before investing in any stock, and deciding on the particular analysis to follow depends on the risk-return preferences of the individual concerned. If one considers investing for a long-term, fundamental analysis may suit the need. On the other hand, technical analysis may help in guiding on short-term investments in stocks.
Prior studies on the fundamental and technical analysis literatures focus on assessing their respective capabilities to explain share price movements. However, the studies establish the effectiveness of the individual methods without reference to each other. In this context, this study seeks to compare the role and utility of both fundamental and technical analysis and, in doing so, to explore the potential use of both the analytical methods by the investors. The study used a mixed methodology research design of a quantitative survey among investors and qualitative interviews. The study also undertook a review of the relevant literature to broaden the knowledge on the subject. Results confirm that individual investors follow their own analysis methods, which do not conform strictly to either fundamental or technical analysis. In most cases both the analytical methods are combined without knowing the basic characteristics of the analytical method. While the findings relate to the stock price movements, they also have implications for dealing in other financial assets also.
In every stock market, investors have the chance to select from a number of stocks and other securities to invest their available funds. Many of the previous research studies have focused on assessing the investment behaviors of stock market investors (Shefrin, 2000; Shleifer, 2000). It is important to explore and understand of investor behavior and to provide them consistent and specific education to enable them make appropriate investment decisions. Because the investment decisions have become more complex in view of the availability of number of financial products, investors have to have thorough understanding of the relative merits and demerits of their investment decisions. The investors must also have the knowledge of how other investment groups are performing in the capital market to guide their own decisions.
Financial theory assumes investors to possess rational decision-making capabilities (Brealey and Mayers, 2003). They consider basic financial management rules and adopt efficient risk-return considerations, while deciding on their investments. However, the degree of risk that each investor prefers to take differs based on whether they are risk-averse or not. Given the same risk level in respect of two available alternative investments, rational investor selects the option that gives the maximum return. Recent research in the field of behavioral finance indicates that many internal and external behavioral factors affect the financial decisions of investors (Shefrin, 2000; Shleifer, 2000). Investors’ own knowledge on the performance of different stocks may be one of the internal factors affecting their investment decisions. On the other hand, the structure and presentation of a financial product is an external factor affecting the investment decisions of the investors. Warneryd (2001), in his review of theory of behavioral finance observe that only little research took place in respect of the behavior of individual investors.
Conventional analysis of the financial reports of firms examines the fundamental values and throws light on the potential for business development and the capacity to add value to shareholders. However, in many cases the current models based on fundamental analysis fail to provide adequate information on past performance and reliable predictions on the future. Largely because of this lack, practitioners are looking beyond fundamental analysis to the help of other non-fundamental influences on stocks including the approach to forecasting. Proliferation of computers and advancements in the information and communication technology provides great help in extended analysis of stock performances to strengthen the investment decisions. According to Goodhart (1988), the interplay between views of professional analysts based on fundamentals and those using other ways of analyzing stock performance influence market outcomes. Shiller (1989) is of the opinion that irrational patterns of investor behavior cause bond and stock volatility, and technical analysis is one of the main causes for the international stock market crash that happened in 1987. Despite the increase in the use of non-fundamental analysis, there is no adequate empirical evidence to prove the prevalence of the new techniques to analyze stock market performance (Lui and Mole, 1998). In this context, this study seeks to compare the role of fundamental and technical analyses in assessing the stock market performance and the ways in which investors perceive the use of these two techniques in evaluating their investment decisions. The study seeks to assist in the presentation of relative importance of the two techniques in assessing the stock performance in any stock market.
Factors affecting Stock Prices
Stock valuation or pricing will become efficient if the stock prices could reflect all available market information to the extent that an uninformed trader would be able to outperform the market. Theorists and practitioners have made many attempts to examine the factors that have an impact on the stock prices. Past research has focused on establishing the correlation between selected factors like internal and external factors, market and non-market factors, economic and non-economic factors and stock prices. Zhang (2006) based on a multi-index model studied the effect of industry, country and international factors on the stock prices. Byers & Groth (2000) define stock pricing process as a function of economic factors and non-economic factors.
According to Clerc & Pfister (2001), in the long-run monetary policies have an impact on the stock prices. Any unexpected changes in the interest rates influence the growth expectations and the rates for discounting future cash flows from investments. Al-Tamimi, (2007) identified several fundamental factors like performance of the company, change in the board of directors, appointment of new management, creation of new assets, information on dividends/earnings have a large impact on the stock prices. He also identified external factors like changes in government regulations and policies, inflation and other economic conditions, investor behavior, market conditions, changes in money supply and position of competition in different industries make the stock prices change. Thus, there are a number of factors, which have an influence on the stock prices. These factors fall into the categories relating to firm, industry, country and international factors with a further sub-division of economic and non-economic factors. Factors in each classification are innumerable having varying degrees of influence on the stock prices.
In general, firm factors like changes in management, capital structure, earnings ratio, dividend payments, and net book value have slightly higher influence on the investment decisions of the retail investors. In order to examine the influence of these factors on stock prices and performance, the investor has to have an in-depth knowledge of both fundamental and technical analyses of stock performance, which is the central focus of this study.
As a student of management, I have been following the debate on the use of fundamental and technical analysis with interest. Recent economic downturn has caused stock prices in different stock exchanges to move up and down, and investors were not able to make better decisions with regard to their investments. This created an additional interest in me to study the available analytical methods of fundamental and technical analysis and compare them to find the suitable system to evaluate the performance of stocks.
Further, advancement in information technology and the desire to gather more information have considerable impact on the ways in which the investors and broking houses are approaching trading in stocks. With the introduction of cheaper processing opportunities and software to acquire additional knowledge in stock performance evaluation, the role of computing technology in stock movement prediction has increased, where these techniques have changed the content and utility of fundamental and technical analysis techniques. Review and comparison of both fundamental and technical analysis in the context of these improved technical applications also provided additional motivation for the current study.
I was curious enough to examine the extent to which the fundamental and technical analyses influence stock purchase decisions in the practical context, as compared to the theoretical discussions on the topic. The desire to understand the practicality of the two “stock performance evaluation” methods acted as motivation to conduct the current study.
Detailed Problem Description
Use of fundamental and technical analysis in taking investment decisions has been a matter of debate since decades. Modern capital market theories and advancement in computing technology and application software, which help in improving the analytical techniques, have changed the scope and utility of both fundamental and technical analyses considerably. In addition to these traditional methods, investors use many other new techniques for helping them to take better investment decisions. Although in practice investors engage several variants of both the techniques, in academia, number of studies has focused on the analysis of these two techniques. Therefore, it becomes important to examine how important these two analytical methods are in the evaluation of stock performance. It is also necessary to explore how investors and professionals use the techniques in their decision making process and the reasons for using these techniques.
Moreover, technical analysis is of relatively high importance as an information category for individual investors as well as fund managers of investment banks. The relative merits and demerits of other methods of evaluating the stock performance need to be examined to ascertain the practical utility of technical analysis. It might be the case investors and fund managers would like to use other ways of information processing. Therefore, it needs to be examined as to whether technical analysis dominates the decision-making of the individual and institutional investors. The relative importance of fundamental analysis in the decision-making processes of investors is to be examined to find the suitability of the analysis method. The study may extend to the examination of technical analysis to find whether the analysis represents a fully rational behavior in the context of efficient market hypothesis and whether it is a rational response to high information costs.
The questionnaire was distributed to 220 respondents during the period from January 2011to March 2011. The samples consisted of two groups – individual investors and brokers. I selected 20 brokerage companies from the Internet database and in turn requested them to provide the profiles and e-mail ids of 20 of their best individual clients. This gave the total number of respondents of 400. Out of the total 400 individual investors, I randomly selected 200 respondents to send the questionnaire. The following table shows the responses received and the response rate appears to be satisfactory.
Table: Response Rate
|Subject Group||Distributed Questionnaire||Returned Questionnaire||Response Rate %|
The purpose of the questionnaire is to examine how investors perceived different techniques under both fundamental and technical analysis to improve the quality of their decision-making. The questionnaire focused on fundamental and technical analyses, which have a long history of being used worldwide. Both the categories included different techniques to be ranked by the respondents. The questionnaire did not specify the nature of these techniques nor the methods they followed. This view was taken because it was assumed that the respondents might use these techniques in different ways and listing the techniques might discourage the respondents from participating in the survey. In view of the simplicity of the questions and the time constraint, no pilot testing was undertaken.
Profile of the Respondents
From the questions requesting the demographic information of the participants, it is observed that majority of the respondents (57.3%) were holding a bachelor’s degree, 22.1 percent of them holding master’s degree and the remaining respondents have completed their school or other education. This sample population can be assuming to make better use of analytical methods in supporting their investment decisions. More than 80 percent of the respondents were having more than 10 years of experience in dealing in stock trading. Majority of the respondents was in the age group of 36-40 years. All the respondents were males.
Findings from the Survey
The first question is on the awareness of the fundamental and technical analyses. The responses are tabulated below.
The responses indicate that 12% of the respondents use technical analysis to guide them in their investment decisions, while 88% of the respondents rely on fundamental analysis.
The respondents were asked to express their opinion on whether the knowledge about fundamental and technical analyses will improve the decision-making in investment and trading in stocks. The following figure represents the responses received from the interviewees.
For the question on whether the respondents follow a system of regularly evaluating their investments in stocks, 76% of the respondents answered that they follow regularly some system to evaluate their investments.
The participants were asked to inform their opinion by ranking different fundamental analysis techniques in improving investment decisions and predicting the stock price movements. The respondents were asked to rank the attributes in a scale of 1 to 5 where “1”is the least important factor having no effect on the assessment of stock movements and “5” is the one having the strongest effect. The responses were given weight based on the ranking the respondents gave and the weighted average was calculated to report the relative position of the attributes in contributing to improvements in decision-making. No distinction was made between the brokers and individual investors in evaluating the effectiveness of the techniques, to maintain the validity of the findings. The following figure represents the responses of the respondents in this respect.
Through the next question, the respondents were asked to rank different technical analytical techniques in aiding the investors in their investment decisions. The above graph represents the responses.
On the question of different expectations to be met by the fundamental and technical analyses the responses of the respondents are presented in the following table.
Table: Expectations of Investors fulfilled by Fundamental and Technical Analysis
|Estimating Stock Returns||4.6|
|Predicting Stock Price Movements||4.4|
|Short-term Forecasting and stock selection||4.2|
|Long-term Forecasting and stock selection||4.2|
|Predicting stock index movements||2.9|
|Switching portfolio investments||1.8|
For the question, whether all investment decisions need to follow some kind of an analysis, 98% of the respondents replied affirmatively. The next question asked the respondents to report on the factors that impede the decision-making process of the investors in general. The questionnaire listed six factors, which are likely to have an influence in the process of making investment decisions by the investors. The respondents were asked to rank these factors according to their perception about the possible effect of these six factors. The following figure represents the responses of the participants.
Finally, the respondents were asked to offer a ranking of different suggestions for improving the effectiveness of analytical methods. The responses are represented graphically below.
Findings from Interviews
Because of time constraint, semi-structured interviews were conducted only with five of the chosen respondents, elaborating further on the survey questionnaire. The profile of the respondents interviewed is presented below.
|Sample||Gender||Age (years)||Educational Level||No. of Years Experience||Status|
|1||Male||36-40||Bachelor’s Degree||8||Individual Investor|
|3||Male||36-40||Masters Degree||10||Individual Investor|
|5||Male||36-40||Bachelor’s Degree||9||Individual Investor|
The interviewees were asked about their perceptions of fundamental and technical analyses and their preference between both the methods. The brokers preferred the use of technical analysis and according to one of the interviewees; he is well versed with the use of specialized software. This knowledge enables him to make appropriate decisions about investing on behalf of his clients many times. He was also of the opinion that technical analysis alone may not be effective in many instances to take investment decisions. Investors must use the fundamental analysis also along with the technical analysis for getting best results. The other broker who was interviewed also supported combining both the analyses methods for better investment decisions. All the three of the individual investors reported that they use only fundamental analysis, for their investment decisions, as they lack the required knowledge to use technical analysis. However, they preferred that they get the necessary training to use technical analysis for guiding them in their decisions. The broker s are of the opinion that while fundamental analysis helped them to take long-term investment decisions, technical analysis enables to advise clients on their short-term investment plans. Individual investors find media and newspapers provide them more support than technical analysis of individual stocks.
The results of the survey reveal that despite the advantages of both technical and fundamental analysis, there is a preference to use fundamental analysis by the individual investors, while the brokers use technical analysis more to take their investment decisions. Even in fundamental analysis, study of annual reports is found to be the most favourite technique for evaluating the investment decisions. Financial newspapers and media reports were the second choice for the respondents. Respondents to the survey have not preferred more scientific analytical methods involving calculations of value based ratios and Economic Value Added (EVA). These results are in conformity with the results of the study conducted by Rosenberg et al (1984), where fundamental analysis based on book-to-market ratio was found to help in identifying the stocks that could yield higher long-term returns.
Respondents to the survey preferred technical indicators from Websites under technical analysis. With the introduction of new software applications, computerized techniques help the investors and brokers. Chart analysis is another preferred method of technical analysis for the investors surveyed, as this method is comparatively easier to use and provide much of the information needed by the investors. Respondents have not preferred the complicated methods of moving averages, momentum or relative strength index, because they might not be able to understand the intricacies of these methods and the ways in which they would be able to help in the decisions of the investors. The results of the current study are in line with the previous study of Mamausky and Wang (2000) which found that technical indicators provided significant incremental information to help in investment decisions.
The results of the survey reveal that in the opinion of the respondents both the fundamental and technical analyses provide more information to the investors on stock returns and information to predict share price movements. In the opinion of the respondents, they could not use these analyses for changing the proportion of stocks in different portfolio investments, as some risks are involved in taking decisions based on these analyses. At the best, the analyses would help in short-term investments and to trade in some of the stocks, where movements are more. In the opinion of the respondents to the survey, most or all of the decisions need to follow certain types of analysis before the investors decide on their investments in stock.
The respondents have found that lack of knowledge in interpreting the financial statements is the important factor that could affect the investment decisions. Participants in the survey also agree on the point that lack of training in technical analysis would be an important factor that impedes investment decisions. Respondents to the survey have not considered lack of peers’ views as a factor that might affect the investment decision.
When the respondents were asked to offer their suggestions for improving the use of analytical methods, they offered taking specialized training on technical analysis as the choice for making better use of technical analysis. Higher use of computing aids is another suggestion offered by the respondents.
The current research sought to study the salient aspects of fundamental and technical analyses, which help in aiding investment decisions and to compare the role and utility of these methods in assessing stock performance. The study undertook a review of the relevant literature and a quantitative survey to achieve the objectives. A qualitative interview with selected respondents was also undertaken as a part of the study. Based on the results of the literature review, the research examined the factors affecting the investment decisions pertaining to stock market investments of investors. Information asymmetry and lack of knowledge in effective use of technical analysis were identified to be the main factors impeding the decision-making process of the investors. The survey conducted as a part of the survey also identified lack of training in using the technical analytical methods and lack of knowledge in using the financial reports and statements as the main impediment in effective decision-making by the investors. The review of the literature enabled the study of the features, role and utility of fundamental and technical analyses of stock performance and added to the body of existing knowledge on the subject. The interview with the respondents revealed the importance of information and analysis in the investment decisions of the investors. The main findings of the study is that most of the individual investors use fundamental analysis in the form of studying the annual reports and other financial statement of companies listed in stock exchanges to get an idea on the long-term performance of the stocks of these companies. However, individual investors do not make use of sophisticated techniques to use the fundamental analysis for assessing the performance of stocks. Brokers tend to use technical analysis, which includes chart analysis and computer aided techniques. Many of the brokers and individual investors prefer to get information on the stocks from the Websites like Google Finance and Bloomberg, which provide all technical data on stocks.
The research suffered a serious limitation in getting the filled questionnaire back from the samples. The samples had to be followed several times to send back the filled questionnaire, which impeded the progress of the research greatly. Another limitation of the study is the generalizability of the results. Since the universe of investing public is large, the samples chosen may not represent the whole of the investing public and to this extent; there is a limitation of the study.
A quantitative study taking the example of specific stocks and assessing their movements, using fundamental and technical analysis and comparing them with actual stock movements would enable testing the applicability of the fundamental and technical analysis in the practical field. Inclusion of other categories of agents and institutions might provide detailed information on the use of these techniques in the real world.
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Appendix I Questionnaire
This questionnaire is presented to you as a part of a research study in presenting a dissertation leading to ——– Degree from the ———- University. All the information you provide will be kept as strictly confidential. Please try to answer all the questions with the options provided against each.
General Demographic Information
- Age Group:
- 18 – 25 years
- 26 – 35 years
- 36 – 40 years
- Above 40 years
- Education Level:
- High School
- Post Graduation
- Length of Experience in Stock Market Operations:
- Less than a Year
- Between one and Five Years
- Between Five and Fifteen Years
- Above Fifteen Years
Questions on Fundamental and Technical Analysis
- Are you aware of Fundamental and Technical Analysis Techniques?
- What is your preferred method of analyzing the stock price movements in between fundamental and technical analysis?
- Fundamental Analysis
- Technical Analysis
- Do you follow a system of regularly evaluating your investments in stocks?
- Please rank the following fundamental analytical techniques in the scale of 1 to 5 where 1 is the least effective and 5 is highly effective.
- Accounting Ratio Analysis
- Value Based Ratio Analysis
- Discounted and other methods
- Study of Annual Reports and financial Statements
- Economic Value Added Method
- Financial Newspapers/Reports
- Other Fundamental analysis methods
- Please rank the following fundamental analytical techniques in the scale of 1 to 5 where 1 is the least effective and 5 is highly effective.
- Chart Analysis
- Technical Indicators from Websites
- Relative Strength Index
- Moving Averages
- Computerized Techniques
- Other Technical analysis methods
- In your opinion, which of the following expectations of investors will be met using the fundamental and technical analysis?
- Predicting stock price movements
- Estimating stock returns
- Short-term forecasting and stock selection
- Long-term forecasting and stock selection
- Switching portfolio investments
- Predicting stock index movements
- Do you agree that all investment decisions should follow some kind of an analysis?
- Which of the following factors, in your opinion, will impede the decision-making process of the investors in general?
- Lack of training in using technical analysis
- Lack of Knowledge to interpret financial statements
- Absence of market information
- Complexity of technical analysis
- Support of technology in the analysis
- Lack of peers’ views
- What is your suggestion for improving the effectiveness of analytical methods?
- Higher use of computing aids
- Taking specialized training on use of technical analysis
- Improving knowledge in interpreting financial reports
- Getting public opinion
- Following financial newspapers and reports