The market for financial securities is thronged by several types of investors that pursue a set of investment approaches which may be divided into categories:
- Fundamental analysis
- Quantitative Analysis
- Psychological approach
For several 100 years, fundamental analysis has commonly been used by the majority of investors, researchers and Advisers. True financial experts know how to calculate the securities intrinsic value, and knows what economic (fundamental) factors the intrinsic value depends upon. Ultimately insightful corporate finance analysts will understand how fundamental factors determine the outlook for the company, its sector and the economy.
It is not unreasonable to believe that the market price of a security differ from its intrinsic value in some cases and at certain periods of time. In fact, financial theories support the view that some securities are less analyzed and, for example, that the market price can lag changes of the intrinsic value. Good amount of returns can be earned by systematically buying under valued securities (securities whose intrinsic value exceeds its market price) and selling over valued securities (securities whose intrinsic value is less than its market value).
Over the recent decades, the academic community in developed economies have suggested comparatively sophisticated research methods to assist you examine various aspects of the financial market. Despite numerous unsolved issues and controversies, the empirical results provide substantial support for the belief that asset prices reflect the intrinsic value fairly well. The financial market is practically efficient, and responds promptly and reasonably to the flow of information.
Therefore, quantitative analysis use the so called random walk theory as a benchmark, when more advanced theories are evaluated. In the park that means past prices cannot be used to predict future prices, more advanced theories strongly suggest that price changes are dependent ('autocorrelated' and 'heteroskedastic'). More advanced theories are consistent with the idea that future returns are both linearly and non linearly associated the assets systematic and non-systematic risk, because there is a positive relationship between risk and return.
The psychological mood of investors, and even the social mood, are believed to influence securities prices. Therefore the psychological and sociological approach are based on the idea that the stock market is not only guided by reason and logic, but by emotions and influences from their social environment. Prices boom during periods of social greed and euphoria and prices crash and spread fear and despair.
While fundamental analysis help determine the intrinsic value, psychic seems to explain why the price deviates from the intrinsic value. It has therefore been suggested that the psychological and sociological approaches tend to analyze how investors are swept by waves of optimism and pessimism.
The psychological approach can be said to encompass technical analysis, which involves analyzing the market data and to recognize persistent and recurring price patterns and to build trading rules that have been beneficial at least historically. In addition to patterns, a variety of technical indicators, such as moving averages, point and figure and bar chart, breadth of market analysis etc, are used in technical analysis.