Fundamental Analysis and Technical Analysis – The Ram and Lakhan of Stock Market
If you are a Bollywood buff, you must have surely heard about the story of the movie Ram-Lakhan. Many of us must also have watched it. Wondering why are we talking about this iconic movie today? This is because the 2 lead characters of the movie – Ram and Lakhan are today going to help us out with the clarity of confusion that we all have in stock markets as investors.
We conducted a poll on twitter to find out what the equity investors generally follow the most before making an investment decision – Fundamental Analysis or Technical Analysis? 75% of the respondents said, they follow both and 25% said that they follow only fundamental analysis.
We are of the opinion that as an investor, it is advisable to follow both Fundamental and Technical Analysis to create wealth across bull runs and bear runs in the market. That is why we termed the combination of both – Fundamental and Technical Analysis as the Ram-Lakhan of Stock Markets.
Let’s check out how the Ram-Lakhan narrative resembles the psychology and impact of Fundamental and Technical Analysis in Stock Markets:
In our case, Ram is Fundamental Analysis and Lakhan is Technical Analysis.
In the story of the movie, Ram is supposed to be an ideal character who believes in discipline, ethics, moral value, loyalty, long-term relationship, etc which are fundamentals of life. Ram believes in “No Pains, No gains”
Similarly, in stock markets – Fundamental Analysis helps an investor make a long-term investment decision based on the Basic Business Segments, News, Annual Reports, Quarterly Results, Any other piece of information related to company, sectoral, political, economic, domestic and global events and developments. Analysing the quality of company, growth aspects, the industry or sectoral performance and comparing it via tools like ratio analysis, beta, public share-holding, pledge portion by promoters of the company aids the assessment of Long Term Financial Strength of the company and its growth over the years which in turn benefits the shareholders of the company.
On the other hand, Lakhan is the character with the mindset that there is nothing wrong if we “Gain without Pain” be it long-term or short-term. The primary motive is to gain and not lose anything.
Technical Analysis in a way studies the 2 major factors in the Stock – Price and Volume with tools like Candlestick Charts, Bollinger Bands, MACD, RSI, etc. Contrarian to the Fundamental Analysis, Technical Analysis assumes that all the news, events etc related to the stock are already estimated at the price and hence if we follow price and volume movements, indicators will suggest the entry and exit points in the stock.
While none of the two Ram and Lakhan were wrong in their beliefs, what made them go wrong was the interpretation and timing of the events that followed in their lives. This happened because none of the two were aware of what to do if things don’t go our way. Both at one or the other point of time remained static and failed to recognize the genuine strengths of the other. That led to disadvantage and they had to suffer.
Similarly, for an investor, it is important to a SWOT analysis of both fundamentals and technical for investing. Fundamentals will help analyze the strength of historic data, growth points, results, news of the company and sector, while technical will help you understand when to enter a stock and when to exit.
Limitations of Fundamentals is the strength of Technical and vice-versa. This can be better understood by comparing 2 phases of the stock market:
Most of us who follow fundamentals, use the following value screening
- Return on Equity > 20%
- Return on Capital Employed > 20%
- Price to Earnings Ratio < 15x
- Price to Book Value < 2x
- 3 Years Sales CAGR to PAT CAGR > 15 to 20%
- 3 Years PAT to CAGR > 15 to 20%
Note: The above screening is indicative and subject to change from case to case
The outcome of the above screening during a bear run in the markets is favorable for investors as it gives:
- Quality Company
- Reasonable Price
- Good Compounders
But what about the bull run when everything is in an uptrend, the fundamental screening above may give:
- Mostly Junk
- Contrarian Sectors
- Value Traps
Getting quality stocks for long term investing will become difficult if an investor follows Fundamental Analysis alone. This is where Technical Analysis comes into play. Technical Analysis as mentioned above follows price-volume of stocks and assumes that all the events are estimated into the price. Hence, it indicates whether a stock is in overbought or oversold zone and whether it is the right time to invest or should an investor wait.
In conclusion, like in the climax of the movie, Ram and Lakhan together fought and won, an investor should use the strength of both fundamental and technical analysis together to win the battle of bulls and bears, be it short-term or long-term.
Stock Book App through its unique tool SBIQ helps investors track this Jodi of Ram and Lakhan, i.e. the Fundamental and Technical Analysis together to tap the opportunities and create wealth for a prosperous and financially independent future.