Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 63

Technical versus fundamental analysis in equity markets

Investors have many different characteristics. At one extreme, high frequency traders rely on technology to place orders with lightning speed and eke out a small percentage profit on huge numbers of small trades in the margin between buyer and seller. At the other extreme, patient, long-term value investors are happy to leave a good stock in the bottom drawer for years or decades, and allow compound returns to work their magic. In between these extremes, there are perhaps as many different investment styles as there are individual investors.

Work out where you sit

One of the major differences divides technical investors (or chartists), who work on the assumption that historical price movements reveal likely future movements, from fundamental (or value) investors, whose focus is future profitability and cash flow. Certainly, there are investors who employ both styles, but most people tend to identify with one or the other. Working out where you sit is one of the more important choices an investor makes.

The two approaches enjoy different levels of acceptance in different parts of the market. Charting can be a relatively simple way to assess the investment merits of a company. Time-poor investors can make decisions more easily and entrepreneurs can design trading ‘systems’ for such time-poor investors. As a result, charting enjoys good support amongst retail investors, and receives quite a few column inches in mainstream media.

In the professional funds management arena, the norm is for analysts and portfolio managers to spend large amounts of time studying the details of company financials and business models. Montgomery Investment Management, along with most of our colleagues in the industry, sits firmly in this fundamental camp. We do this with the expectation that investing time and effort into having deeper insight into a business will yield better investment decisions.

A good question for investors and fund manager clients to ask is: does this extra effort and cost add enough value to be worthwhile? If a simple approach delivers reasonable results, why bother with the hard way?

There may be no single right answer. Any investment approach needs to fit the personal style of the investor using it. For example, if you have perfectionist tendencies and time on your hands, you will want to follow a different path to someone with a short attention span and other things to do. However, there are some reference points that are relevant to all investors.

Firstly, returns. How much value can be delivered by charting? Many people have a strong view that it adds either: a) zero value, or b) quite a lot of value, but based on academic research, the correct answer is probably: c) neither (depending on exactly what we mean by charting).

A role for momentum and reversal

Over the years, charting has generally not enjoyed a high level of credibility in academic circles, but a seminal piece of work was published in August 2000 by Andrew Lo, Harry Mamaysky and Jiang Wang at MIT. Using sophisticated techniques, these researchers examined the merits of a wide range of shapes and patterns, and they found a few surprises.

Their work confirmed the widely-held view that traditional charting concepts like support and resistance do not have practical value. However, they showed that two technical indicators – momentum and reversal – do have value. Put simply, they (as well as other researchers) confirmed that stocks that have performed well in the recent past (typically up to 12 months) tend to perform well in the future, whereas stocks that have performed well over longer periods of time (3-5 years) tend to underperform in future. These so called ‘anomalies’ are now widely accepted as real, and it is possible to construct profitable trading strategies that exploit them.

On this basis, there is value in technical analysis. However, that value is somewhat limited. Different studies show different results, but as a general observation, after allowing for trading costs and risk it is not entirely clear that reversal strategies work in the real world, and there have been extended periods when momentum strategies haven’t worked, notably around the time of the GFC.

While esoteric concepts like ‘head and shoulders’ patterns are unlikely to help much in the real world, there probably is merit in the old adage ‘the trend is your friend’, and having a disciplined approach to trend-following appears to be a simple and legitimate way to generate returns that beat the market by a noticeable margin. However, the upside is less than compelling, and there is another saying about rich chartists being a very rare breed.

While it is easy to draw up a long list of spectacularly successful and wealthy fundamental investors, coming up with a list of comparable technical analysts would be rather more challenging. Accordingly, if your aspirations for investment success lie beyond ‘a noticeable margin’ then you may be better off putting in the hard yards of fundamental analysis, or find a good manager to do it for you.

 

Roger Montgomery is the Founder and Chief Investment Officer at The Montgomery Fund, and author of the bestseller ‘Value.able

 


 

Leave a Comment:

RELATED ARTICLES

Cheap stocks: how to find them and how to buy them

Technical analysis using four trading tools

A Christmas fireside chat

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

The 2025 Australian Federal election – implications for investors

With an election due by 17 May, we are effectively in campaign mode with the Government announcing numerous spending promises since January and the Coalition often matching them. Here's what the election means for investors.

Latest Updates

World's largest asset manager wants to revolutionise your portfolio

Larry Fink is one of the smartest people in the finance industry. In his latest shareholder letter, the Blackrock CEO outlines his quest to become the biggest player in private assets and upend investor portfolios.

Economy

Australia's economic report card heading into the polls

Our economy grew by a nominal rate of 7% per annum from 2017 to 2024, but it benefited from the largesse of fiscal and monetary policies, both of which are now fading. We need a new, credible economic growth agenda.

Preference votes matter

If the recent polls are anything to go by, we are headed for a hung parliament at the upcoming federal election. So more than ever, Australians need to give serious consideration to their preference votes.

SMSF strategies

Meg on SMSFs: Tips for the last member standing

It’s common for people as they age to seek more help in running their SMSF if their capacity declines. An alternate director may be a great solution for someone just planning for short-term help in the meantime.

Wilson Asset Management on markets and its new income fund

In this interview, Matthew Haupt from Wilson Asset Management discusses his outloook for the ASX, sectors such as REITs that he likes, and his firm's launch of a new income-oriented listed investment company.  

Planning

‘Life expectancy’ – and why I don’t like the expression

Life expectancy isn't just a number - it's a concept that changes with survival rates over time. This article breaks down how age, survival, and societal factors shape our understanding of life expectancy, especially post-Covid. 

The shine is back on gold, and gold miners

Gold mining stocks outperformed in 2024 and are expected to do well in 2025. At this point in the rally, it's worth considering what has driven gold prices higher and why miners could still have some catching up to do.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.