Fundamental and Technical analysis

Fundamental analysis

A method of security valuation which involves examining the company's financials and operations, especially sales, earnings, growth potential, assets, debt, management, products, and competition. Fundamental analysis takes into consideration only those variables that are directly related to the company itself, rather than the overall state of the market or technical analysis data.

Meaning

Fundamental analysis is basing the valuation of an asset on important economic reports. In forex trading, we refer to these reports as economic indicators. Comparing the employment reports from two countries and making a trade based on that information would be an example of using fundamental analysis. Fundamental analysis maintains that markets may misprice a security in the short run but that the "correct" price will eventually be reached. Profits can be made by trading the mispriced security and then waiting for the market to recognize its "mistake" and reprice the security

objectives

Fundamental analysis is performed on historical and present data, but with the goal of making financial forecasts. There are several possible objectives: to conduct a company stock valuation and predict its probable price evolution, to make a projection on its business performance, to evaluate its management and make internal business decisions, to calculate its credit risk.

Use by different portfolio styles

Buy and hold Buy and hold investors believe that latching onto good businesses allows the investor's asset to grow with the business. Fundamental analysis lets them find 'good' companies, so they lower their risk and probability of wipe-out. Managers may use fundamental analysis to correctly value 'good' and 'bad' companies. Even 'bad' companies' stock goes up and down, creating opportunities for profits. Managers may also consider the economic cycle in determining whether conditions are 'right' to buy fundamentally suitable companies.

Contrarian investors Contrarian investors distinguish "in the short run, the market is a voting machine, not a weighing machine". Fundamental analysis allows you to make your own decision on value, and ignore the market.

Value investors Value investors restrict their attention to under-valued companies, believing that 'it's hard to fall out of a ditch'. The value comes from fundamental analysis. Managers may use fundamental analysis to determine future growth rates for buying high priced growth stocks. Managers may also include fundamental factors along with technical factors into computer models (quantitative analysis).

Top-down and Bottom-up

a)

The top-down investor starts his analysis with global economics, including both international and national economic indicators, such as GDP growth rates, inflation, interest rates, exchange rates, productivity, and energy prices. He or she narrows his search down to regional/industry analysis of total sales, price levels, the effects of competing products, foreign competition, and entry or exit from the industry. Only then does he narrow his search to the best business in that area. The bottom-up investor starts with specific businesses, regardless of their industry/region.

Procedure of analysis

The analysis of a business' health starts with financial statement analysis that includes ratios. It looks at dividends paid, operating cash flow, new equity issues and capital financing. The determined growth rates (of income and cash) and risk levels (to determine the discount rate) are used in various valuation models. The foremost is the discounted cash flow model, which calculates the present value of the future

Contd.

The determined growth rates (of income and cash) and risk levels (to determine the discount rate) are used in various valuation models. dividends received by the investor, along with the eventual sale price. earnings of the company, or cash flows of the company.

Contd

For measurement of debt,debt equity ratio is used For time value of money PE ratio is used

Technical analysis

Technical Analysis: Study of past market action to forecast price Looks for patterns in historical data

Technical Analysis Tools

Charting Gann Cycle Theory Oscillators & Indicators Japanese Candlesticks Market Profile Computerized Trading Systems

Support & Resistance

Support: Price where buying power is sufficient to halt downtrend Bears are hurting, start buying Resistance: Price where selling power is sufficient to halt uptrend Bulls are hurting, start selling Support & Resistance Lines Draw horizontal lines through congestion areas At upper and lower limits of trading range

Support & Resistance Lines