FIN521 Chap.8 Fundamental and Technical Analysis
Fundamental and Technical Analysis
Evaluate, not describe
One of the five published outcomes requires a student to weigh up what each of the two analytical traditions can actually establish when money is at stake, and on the final paper that criterion is weighted at thirty per cent, level with the largest. Evaluate is the operative word.
The examiner is not asking for a description of the two approaches, which any textbook supplies; the examiner is asking what each one is entitled to establish. Almost all the marks lost here go to answers that are technically informed and never perform that separation.
Two techniques, two different inputs
Fundamental analysis reasons from the business to the price.
It estimates what a security is worth from the cash the underlying business can be expected to generate, working from the economy and interest rates through the industry to the company's own accounts, and compares that estimate with the market price. Technical analysis reasons from the price to the price. It studies past prices and traded volume for patterns taken to carry information about future prices.
The inputs do not overlap, so evidence drawn from one column cannot support a claim belonging to the other, and welding the two together is the error this chapter exists to prevent.
State the technical case fairly before testing it
At its strongest the technical case rests on three claims: that prices reflect participants' collective behaviour, that behaviour has persistent features, and that those features leave traces in the series before being fully reflected in the price.
None is absurd, and an answer that dismisses the approach without stating them has attacked a position nobody defends. The standard objection is also the strongest: if prices already reflect all available information then past prices are part of that information and no rule built on them can produce excess returns.
Note that the objection requires the efficiency claim, which the first chapter of this course treated sceptically, so the honest position is conditional rather than dismissive.
What would count as evidence
A pattern visible on a chart after the fact is not evidence, because a flexible enough pattern language fits any series that has already happened.
A track record of profitable trades is not evidence either, unless you know how many strategies were tried and discarded to produce it. Both failures have the same shape: selection happened before you were shown the result. The test that would count is a rule fixed in advance, applied mechanically to data it was not built on, with spread and commissions deducted.
A rule that fails can always be refined, and a refined rule tested on the same data is no longer a prediction, which is why the debate is durable rather than settled.
What this chapter covers
- 01
Why the rubric weights this criterion at thirty per cent
- 02
Fundamental analysis and the outside-in order of the work
- 03
Where the analyst's judgement enters a valuation
- 04
Technical analysis stated at its strongest
- 05
Trend following against contrarian rules and their opposite assumptions
- 06
The efficient market objection and what it presupposes
- 07
Patterns found after the fact, and track records with hidden selection
- 08
The three forms of market efficiency and which information set each names
- 09
Separating a value claim from a momentum claim in one answer
Say what each half of a recommendation is entitled to establish
- 3Classify each ground and name the evidence it draws on.
- 4State what the fundamental ground establishes and the condition on it.
- 3State what the technical ground can and cannot support.
Key terms
- Fundamental Analysis
- Estimating what a security is worth from the cash the underlying business can generate, then comparing that estimate with the market price.
- Technical Analysis
- Studying past prices and traded volume for patterns treated as carrying information about future prices.
- Weak Form Efficiency
- The claim that prices already reflect all past price and volume information, which is exactly the information technical rules use.
- Semi Strong Efficiency
- The claim that prices reflect all publicly available information, including the published accounts fundamental analysis reads.
- Trend Following
- A family of technical rules that identify a move already under way and stay with it, on the view that participants adjust gradually.
- Contrarian Rule
- A family of technical rules that identify an overreaction and take the other side, on the opposite behavioural assumption to trend following.
- Out Of Sample Test
- Applying a rule fixed in advance to data it was not built on, with costs deducted, which is the only test that can fail.
Fundamental and Technical Analysis FAQ
Is technical analysis worth studying if markets are efficient?
The conditional matters more than the answer. If markets are efficient in the weak sense then past prices carry no unexploited information and no rule built on them can earn excess returns, so the approach fails.
Whether markets are efficient in that sense is an empirical question this course does not claim to settle, and the first chapter quotes the observation that a market can stay irrational longer than an investor can stay solvent. An answer that names the condition scores better than one that picks a side.
What is wrong with a fund manager's track record as evidence?
Nothing, if you also know the denominator. A record of profitable trades is compelling only when you know how many strategies were tested and abandoned before that one was presented, because selection from a large enough set produces impressive records by chance. The same objection applies to a chart pattern identified after the series has played out.
In both cases the selection happened before the evidence reached you, which is what makes the evidence uninformative rather than merely weak.
How should I handle a valuation that is far above the market price?
Ask two questions before acting. First, which single assumption is producing the gap, and what happens to the conclusion if that assumption is halved; a valuation far from the market usually rests on one growth or margin figure.
Second, what the market may know that the model does not, because a large gap is equally consistent with the analyst being right and with the analyst having missed a risk that other participants have priced.
Exam move
Collect three broker notes or newspaper recommendations and, for each, underline the sentences that draw on accounts and circle the sentences that draw on prices. Then write one line saying what each group establishes.
Twenty minutes of that is worth more than rereading the chapter, because the criterion this section is graded against rewards the separation itself rather than knowledge of either technique, and the separation only becomes fast with repetition.
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