Unlike fundamental analysis of stocks, technical analysis doesn’t consider value, growth, income and management’s effectiveness. It relies purely on numbers and charts. Technical analysis uses a wide variety of charts that show price over time. This usually helps to estimate what the future price of a stock may be after studying the past trends as they rely on the principle that ‘history repeats itself’.

Assumptions on which technical analysis work

There are 3 assumptions on which technical analysis of stocks is done. These are:

1. The market discounts everything.
2. Price moves in trends.
3. History tends to repeat itself.

Types of charts used in stock technical analysis

The various types of charts being used in technical analysis are:

OHLC (Open high low close charts) – These charts are bar charts in which the high and low price movement of a stock is charted vertically and open and close are charted horizontally. This chart is used to graph outliners and ranges.

Candlestick charts – This chart is similar to open high low close charts but open and close are filled. Often Black or Red candles represent a close lower than the open. And White, Green or Blue candles represent a close higher than the open.

Line charts – These are the simplest of charts which are charted on close price of a stock over a period of time. Analysts believe that the closing price is the most important price of a security.

Charts are one of the most fundamental aspects of technical analysis. It is important that you clearly understand what is being shown on a chart and the information that it provides. Let’s take a look at how are trends noticed in charts. We are only covering the topics on analyzing the stock trends in this article. We would have a separate article discussing technical analysis of stock trends to go deep into this topic.

1. Head and shoulders
2. Cup and handle
3. Double tops and bottoms
4. Triangles
5. Flag and pennant
6. Wedge
7. Gaps
8. Triple tops and bottoms
9. Rounding bottom

These are the most popularly used trends and chart patterns which would help you understand price movement of stock.

Price-based indicators

Price based indicators are very important and are derived from these charts and historical prices. These indicators are generally shown below or above the main price chart.

Accumulation/distribution index—based on the close within the day’s range

Advance decline line — a popular indicator of market breadth

Average Directional Index — a widely used indicator of trend strength

Commodity Channel Index – identifies cyclical trends

MACD – moving average convergence/divergence

Parabolic SAR – Wilder’s trailing stop based on prices tending to stay within a parabolic curve during a strong trend

Relative Strength Index (RSI) – oscillator showing price strength

Rahul Mohindar Oscillator – a trend identifying indicator

Stochastic oscillator, close position within recent trading range

Trix – an oscillator showing the slope of a triple-smoothed exponential moving average, developed in the 1980s by Jack Hutson

Similar to price based indicators there are a few volume based indicators as well:

Money Flow – the amount of stock traded on days the price went up

On-balance volume – the momentum of buying and selling stocks

PAC charts – two-dimensional method for charting volume by price level

Related posts:

1. Technical analysis of stock trends – Volume, Aroon and Fibonacci
2. MACD technical analysis
3. Candlestick Stock Chart Analysis – Introduction

The main aim of doing fundamental analysis is to be able to decide whether it is a good idea to buy a security, hold it or sell it based on its current price. Using fundamental analysis, this type of decision can be made. This type of valuation can be done for stocks as well as any other type of security like forex, options etc.

Fundamental analysis of stock is done on current as well as historical data with the hope of predicting the financial forecasts of a company. Fundamental analysis of stock can be done to answer questions about a company like:

• Is the company’s revenue growing or not?
• Is the company making any profit?
• Will it be able to survive competition and beat it?
• Will it be able to repay its debts?
• Is the management effectively running the business or is it cooking books?
• What is the credit risk of the company?
• And many more…

As mentioned in stock analysis for beginners, fundamental analysis is done based on a few factors like value, growth, GARP, income and quality. Let’s take a look at these factors.

The main purpose of choosing one stock over others is the intrinsic value of that stock. All investors would like to know the value of stock so that they know what profits they will get in case they sell it tomorrow. But, determining value is not a straight forward task. Beginners should understand that although most value investors believe in certain things, not all who use the word “value” mean the same thing.

Growth investing is done by those who think that the company will grow in future at a reasonable pace. Growth is very frequently linked with relatively new companies which have the potential to grow faster than already established ones.

Many people invest not just for value, nor do they look for future growth of the company. They simply invest in a stock because it has a good history of giving out dividends. These types of investors are called income investors.

GARP (Growth at reasonable price) is another concept used by practitioners believing in fundamental analysis of stock. This is basically a combination of value and growth theories and then it puts an additional numerical slant to the equation. One of the common GARP approaches is to buy stocks when the P/E ratio is lower than the rate at which earnings per share can grow in the future. Since GARP uses numbers in its equation, some people believe that it is a part of quantitative analysis instead of fundamental analysis.

Quality – People who want a real quality stock look at all the above factors – growth, value, GARP and income to decide upon a high quality stock. In this theory, fundamentals like management competitiveness along with numerical figures like return on equity (ROE) are looked at in totality. The qualitative and quantitative factors are looked in conjunction to find the real quality stock.

Fundamental Analysis Tools

There are various tools or financial ratios which are used to do fundamental analysis. Some of them are:

1. Earnings per Share – EPS
2. Price to Earnings Ratio – P/E
3. Projected Earning Growth – PEG
4. Price to Sales – P/S
5. Price to Book – P/B
6. Dividend Payout Ratio
7. Dividend Yield
8. Book Value
9. Return on Equity

Criticism of fundamental analysis technique

There are mainly two arguments against fundamental analysis of stocks. One argument is that this analysis is done based on public information which is known by all. Since it is public information, there is no advantage which can be taken by one analyst over another.

Other argument is that a lot of things in this analysis are not properly defined. They are fuzzy so to speak. Therefore these terms like value and growth can be interpreted by different people in different ways.

Related posts:

1. Stock Analysis for beginners – Stock Analysis Techniques
2. Quantitative analysis of stocks
3. Technical analysis of stocks