A Random Walk Down Wall Street

Technical analysis uses the castle-in-the-air theory, and fundamental analysis uses the firm-foundation theory. Technical analysts, or chartists, study the behavior of investors to predict future behavior, while fundamental analysts try to determine a stock’s intrinsic value to predict market performance. Chartists ignore assets and earnings, focusing solely on the pattern of sales and purchases of a company’s stock. When the price shows an upward trend, they buy, and then they sell when they predict the stock is about to make a downward trend. Charting often leads to missing opportunities by buying too late or selling too early, though advances in technology have sped up the process of creating charts.

Fundamentalists rely on the predicted performance of a company, using expected growth rate, dividend payout, degree of risk, and level of market interest rates. Predicting growth rate is difficult, but rational investors are willing to pay more for stocks in companies that either have a large growth rate or are expected to have a long growth period. Growth is measured with P/E multiple, or price-earnings, which compare the relative cost of a stock with the earnings made by the stock. Larger dividends or offers to buy back stock can also justify higher stock prices, while large fluctuations in price, indicating risk, can lower prices.