Capital Market Analysis PDF

CAPITAL MARKET FIMA 30083: WEEK 10-12 FINANCIAL RATIO ANALYSIS AND FUNDAMENTAL ANALYSIS Efficiency Ratios - Analyzing Operational FINANCIAL RATIO ANALYSIS...

CAPITAL MARKET FIMA 30083: WEEK 10-12 FINANCIAL RATIO ANALYSIS AND FUNDAMENTAL ANALYSIS Efficiency Ratios - Analyzing Operational FINANCIAL RATIO ANALYSIS Efficiency Market Ratios - Gauging Market Perception and Valuation 1.0 OBJECTIVES Definition and Importance of Financial Ratio 5.0 LIQUIDITY FINANCIAL RATIOS Analysis Purpose and Usage of Financial Ratios in Decision-Making INTERPRETA Major Categories of Financial Ratios RATIO FORMULA TION Liquidity Financial Ratios Solvency Financial Ratios Measures ability Profitability Financial Ratios to meet Current Assets / Efficiency Financial Ratios Current Ratio Current Liabilities short-term Market Financial Ratios obligations using FInancial Ratio Computations and Analysis current assets Limitations of Financial Ratios Measures Sample Video immediate (Current Assets - liquidity, 2.0 WHAT IS RATIO ANALYSIS? Quick Ratio Inventory) / excluding Current Liabilities inventory, to Ratio Analysis - Involves methods of calculating and cover short-term interpreting financial ratios to analyze and monitor a obligations firm’s performance. Measures ability Financial Ratios - Are numerical expressions that to meet Cash and Cash short-term indicate the relationship between various financial Cash Ratio Equivalents / obligations using statement items, such as assets, liabilities, revenues, and Current Liabilities only cash and expenses. cash equivalents, conservatively These ratios are important for businesses, investors, creditors, and other stakeholders as they help in evaluating a company’s financial health, performance, 6.0 SOLVENCY FINANCIAL RATIOS and market position. PURPOSE AND USES OF FINANCIAL INTERPRETA 3.0 RATIO FORMULA RATIOS IN DECISION-MAKING TION Assessing a company’s financial stability, Measures profitability, efficiency, and market valuation. proportion of Aid decision-makers in analyzing business Total Liabilities / assets financed by Debt Ratio performance, conducting industry comparisons, Total Assets debt, indicating identifying trends, and making informed financial leverage and risk exposure investment and financial decisions. Measures MAJOR CATEGORIES OF FINANCIAL proportion of 4.0 assets financed by RATIOS Total Equity / Equity Ratio shareholder’s Total Assets Liquidity Ratios - Assessing Short-Term equity, showing Financial Health capital structure Solvency Ratios - Evaluating Long-Term and stability Financial Stability Profitability Ratios - Measuring Financial Compress debt Debt-To-Equity Total Liabilities / financing to Performance Ratio Total Equity equity financing, JUSTINE CONTRERAS, BSBA FM 4-5 1  FINANCIAL RATIO ANALYSIS AND FUNDAMENTAL ANALYSIS assessing measuring how financial risk and often inventory is leverage sold and replaced Measures ability Provides insights Earnings Before to meet interest into credit and Interest Interest and Taxes payments on debt, Net Credit Sales / collection policy Receivables Coverage Ratio (EBIT) / Interest indicating Average Accounts efficiency by Turnover Ratio Expense financial stability Receivable measuring how and risk exposure often receivables are collected 7.0 PROFITABILITY FINANCIAL RATIOS Reflects payment efficiency and Cost of Goods short-term debt Payables Sold / Average management by INTERPRETA Turnover Ratio RATIO FORMULA Accounts Payable measuring how TION often suppliers are paid Measures gross profitability and Indicates overall pricing strategy asset Gross Margin Gross Profit / Net effectiveness by management Ratio Sales considering sales effectiveness by revenue and Asset Turnover Net Sales / Total measuring how COGS Ratio Assets efficiently assets are utilized to Provides insights generate sales into operational revenue efficiency and Operating Operating Income profitability by Margin Ratio / Net Sales considering sales 9.0 MARKET FINANCIAL RATIOS revenue and expenses Reveals overall INTERPRETA RATIO FORMULA profitability and TION financial Net Profit Net Income / Net performance by Indicates market’s Margin Ratio Sales considering sales perception of a revenue and net company’s growth Market Price per profit Price-To-Earnin potential and Share / Earnings gs (P/E) Ratio stock valuation by per Share (EPS) Measures measuring price management’s investors pay per Return on Net Income / dollar of earnings effectiveness in Assets (ROA) Total Assets utilizing assets to generate profit Provides insights into the market’s Indicates the assessment of the company’s ability firm’s sales Market Price per to generate Price-To-Sales performance and Share / Sales per Return on Net Income / returns for (P/S) Ratio growth prospects Share Equity (ROE) Total Equity investors by by measuring relating value investors profitability to place on each equity dollar of revenue Offers insights 8.0 EFFICIENCY FINANCIAL RATIOS into the market’s perception of the firm’s underlying Market Price per asset value and INTERPRETA Price-To-Book RATIO FORMULA Share / Book potential for TION (P/B) Ratio Value per Share future growth by measuring value Indicates investors place on Cost of Goods Inventory inventory each dollar of net Sold / Average Turnover Ratio management assets Inventory effectiveness by JUSTINE CONTRERAS, BSBA FM 4-5 2  FINANCIAL RATIO ANALYSIS AND FUNDAMENTAL ANALYSIS Provides insights Total Assets $ 3,597 $ 3,270 into the income-generatin Annual Dividends g potential of a per Share / stock relative to LIABILITIES AND STOCKHOLDERS’ Dividend Yield EQUITY Market Price per its price by Share measuring the return on Accounts $ 382 $ 270 investment from Payable dividends Notes Payable 79 99 10.0 SAMPLE FINANCIAL STATEMENT Accruals 159 114 TOTAL BARTLETT COMPANY CURRENT $ 620 $ 483 LIABILITIES BALANCE SHEET Long-Term FOR THE YEARS ENDED DECEMBER 31 Debt (includes financial 2019 2018 leases) 1,023 967 ASSETS TOTAL LIABILITIES $ 1,643 $ 1,450 Cash $ 3630 $2880 Preferred Marketable Stock: 680 51,000 Securities Cumulative 5%, $100 Par, $ 200 $ 200 Accounts 2,000 Shares 503 365 Receivable Authorized and Issued Inventories 289 300 Common TOTAL Stock: $2.50 CURRENT Par, 100,000 ASSETS $ 1,223 $ 1,004 Shares Authorized, 191 191 Land and Shares Issued $ 2,072 $ 1,903 Buildings and Outstanding in: Machinery and 2019: 76,262 1,866 1,693 Equipment 2018: 76, 244 Furniture and Paid-In Capital 358 316 Fixtures in Excess of Par 428 417 on Common Vehicles 275 314 Stock Other (includes Retained financial Earnings 1,135 1,012 leases) 98 96 TOTAL TOTAL GROSS STOCKHOLDE FIXED ASSETS $ 4,669 $ 4,322 RS’ EQUITY $ 1,954 $ 1,820 (AT COST) TOTAL LESS: LIABILITIES Accumulated AND Depreciation 2,295 2,056 STOCKHOLDE RS’ EQUITY $ 3,597 $ 3,270 Net Fixed Assets $ 2,374 $ 2,266 JUSTINE CONTRERAS, BSBA FM 4-5 3  FINANCIAL RATIO ANALYSIS AND FUNDAMENTAL ANALYSIS BARTLETT COMPANY Earnings per $ 2.90 $ 1.81 Share (EPS)a INCOME STATEMENT Dividend per FOR THE YEARS ENDED DECEMBER 31 $ 1.29 $ 0.75 Share (DPS)b 2019 2018 A. Calculated by dividing the earnings available for Sales Revenue $ 3,074 $ 2,567 common stockholders by the number of shares of common stock outstanding: LESS: Cost of 2019: 76,262 Goods Sold 2,088 1,711 2018: 76,244 GROSS Earnings per Share: PROFITS $ 986 $ 856 2019: $ 221,000 / 76,262 = $ 2.90 2018: $ 138,000 / 76,244 = $ 1.81 LESS: Operating B. Calculated by dividing the dollar amount of Expenses dividends paid to common stockholders by the number of shares of common stock outstanding. Selling Expense $ 100 $ 108 Dividends per Share: General and 2019: $ 98,000 / 76,262 = $ 1.29 Administrative 194 187 2018: $ 57,183 / 76,244 = $ 0.75 Expenses 11.0 LIQUIDITY FINANCIAL RATIOS Other Operating 35 35 Expenses 11.1 CURRENT RATIO Depreciation *BASED ON THE FINANCIAL STATEMENTS ABOVE* Expense 239 223 Current Ratio = Current Assets / Current Liabilities Current Ratio = $ 1,223,000 / $ 620,000 TOTAL Current Ratio = 1.97 Times OPERATING EXPENSE $ 568 $ 553 It measures the ability of the company to pay its current obligations using its current assets. OPERATING The higher the current ratio, the better, it $ 418 $ 303 indicates a greater degree of liquidity. Choose a PROFITS company with a current ratio of more than 1. LESS: Interest Expense 93 91 11.2 QUICK RATIO (ACID-TEST RATIO) NET PROFITS *BASED ON THE FINANCIAL STATEMENTS ABOVE* BEFORE $ 325 $ 212 Quick Ratio = (Current Assets - Inventories) / Current TAXES Liabilities Quick Ratio = ($ 1,223,000 - $ 289,000) / $ 620,000 LESS: Taxes 94 64 Quick Ratio = $ 934,000 / $ 620,000 Quick Ratio = 1.5 Times NET PROFITS $ 231 $ 148 AFTER TAXES It provides a better measure of the firm’s overall liquidity than the current ratio. LESS: The higher the quick ratio, the better. Preferred Stock Dividends 10 10 12.0 EFFICIENCY FINANCIAL RATIOS Earnings Available for Common 12.1 INVENTORY TURNOVER RATIO Stockholders $ 221 $ 138 *BASED ON THE FINANCIAL STATEMENTS ABOVE* Inventory Turnover Ratio = Cost of Goods Sold / Inventory Inventory Turnover Ratio = $ 2,088,000 / $ 289,000 Inventory Turnover Ratio = 7.2 Times JUSTINE CONTRERAS, BSBA FM 4-5 4  FINANCIAL RATIO ANALYSIS AND FUNDAMENTAL ANALYSIS Average Payment Period = 95 Days It measures the activity, or liquidity of a firm’s inventory. It measures the number of days it takes for a The resulting turnover is meaningful only when it company to pay its obligations. is compared with that of other firms in the same The average payment period is meaningful only industry or to the firm’s past inventory turnover. in relation to the average credit terms extended to the firm. 12.2 AVERAGE AGE OF INVENTORY 12.7 TOTAL ASSETS TURNOVER RATIO Average Age of Inventory = 365 Days / Inventory Turnover Ratio *BASED ON THE FINANCIAL STATEMENTS ABOVE* Average Age of Turnover = 365 / 7.2 Total Assets Turnover Ratio = Sales / Total Assets Average Age of Turnover = 50.7 Days Total Assets Turnover Ratio = $ 3,074,000 / $ 3,597,000 Total Assets Turnover Ratio = 0.85 Times It measures the number of days of inventory the firm has on hand. It indicates the efficiency with which the firm The less number of days, the better. uses its assets to generate sales. The higher a firm’s total assets turnover, the more efficiently its assets have been used. 12.3 RECEIVABLES TURNOVER RATIO *BASED ON THE FINANCIAL STATEMENTS ABOVE* 13.0 SOLVENCY FINANCIAL RATIOS Accounts Receivable Turnover Ratio = Sales Revenue / Accounts Receivable Accounts Receivable Turnover Ratio = $ 3,074,000 / $ 13.1 DEBT RATIO 503,000 Accounts Receivable Turnover Ratio = 6.11 Times *BASED ON THE FINANCIAL STATEMENTS ABOVE* Debt Ratio = Total Liabilities / Total Assets It measures how well firms manage their credit Debt Ratio = $ 1,643,000 / $ 3,597,000 and collection. Debt Ratio = 45.7% The higher the better. This value indicates that the company has financed close to half assets with debt. 12.4 AVERAGE COLLECTION PERIOD The higher this ratio, the greater the amount of Average Collection Period = 365 Days / Accounts other people’s money being used to generate Receivable Turnover Ratio profits. Average Collection Period = 365 / 6.11 Average Collection Period = 59.7 Days 13.2 DEBT-TO-EQUITY RATIO It measures the number of days to collect *BASED ON THE FINANCIAL STATEMENTS ABOVE* accounts receivable. Debt-To-Equity Ratio = Total Liabilities / Total The average collection period is meaningful only Stockholders’ Equity in relation to the firm’s credit terms. Debt-To-Equity Ratio = $ 1,643,000 / $ 1,954,000 Debt-To-Equity Ratio = 84.08% 12.5 PAYABLES TURNOVER RATIO It means that creditors provide 85 cents for each *BASED ON THE FINANCIAL STATEMENTS ABOVE* peso provided by stockholders. This ratio Assumption: Purchases is 70% of Cost of Goods Sold measures a company’s financial leverage. It Accounts Payable Turnover Ratio = Net Purchases / should be used to compare companies within the Accounts Payable same industry since a relatively high or low D/E Accounts Payable Turnover Ratio = $ 2,088,000 x 0.70 / Ratio varies from industry to industry for most $ 382,000 companies. D/E Ratios should be 1.5 or less; for Accounts Payable Turnover Ratio = $ 1,461,600 x / $ large public or capital-intensive companies, 2. 382, 000 A high D/E Ratio is often associated with high Accounts Payable Turnover Ratio = 3.83 Times risk. For a conservative investor, with low risk tolerance, look for stocks with an acceptable D/E It measures how well firms manage their Ratio of less than 1. payables. The higher the better. TIME INTEREST EARNED RATIO (INTEREST 13.3 COVERAGE RATIO) 12.6 AVERAGE PAYMENT PERIOD *BASED ON THE FINANCIAL STATEMENTS ABOVE* Average Payment Period = 365 Days / Accounts Payable Time Interest Earned Ratio = Earnings Before Interest Turnover Ratio and Taxes (OI) / Interest Expense Average Payment Period = 365 / 3.83 Time Interest Earned Ratio = $ 418,000 / $ 93,000 JUSTINE CONTRERAS, BSBA FM 4-5 5  FINANCIAL RATIO ANALYSIS AND FUNDAMENTAL ANALYSIS Time Interest Earned Ratio = 4.5 Times A higher EPS indicates more value as investors will pay more of a company with higher profits. Measures the firm’s ability to make contractual The higher the EPS, the better. Choose stocks interest payment. with high EPS. The higher its value, the better able the firm to fulfill its interest obligations. 14.5 RETURN ON ASSETS *BASED ON THE FINANCIAL STATEMENTS ABOVE* 14.0 PROFITABILITY FINANCIAL RATIOS Return on Assets = Earnings Available for Common Shareholders / Total Assets Return on Assets = $ 221,000 / $ 3,597,000 14.1 GROSS PROFIT MARGIN RATIO Return on Assets = 6.1% *BASED ON THE FINANCIAL STATEMENTS ABOVE* Gross Profit Margin Ratio = Gross Profit / Total Revenue Also known as Return on Investments (ROI). It Gross Profit Margin Ratio = $ 986,000 / $ 3,074,000 measures the overall effectiveness of Gross Profit Margin Ratio = 32.1% management in generating income with its available assets. It measures the percentage of each sales peso The higher the firm’s return on assets, the better. remaining after the firm has paid for its goods. The higher the firm’s gross profit margin, the 14.6 RETURN ON COMMON EQUITY better. *BASED ON THE FINANCIAL STATEMENTS ABOVE* Return on Common Equity = Earnings Available for 14.2 OPERATING PROFIT MARGIN RATIO Common Shareholders / Common Stock Equity *BASED ON THE FINANCIAL STATEMENTS ABOVE* Return on Common Equity = $ 221,000 / ($ 191,000 + $ Operating Profit Margin Ratio = Operating Profit / Total 428,000 + $1,153,000) Revenue Return on Common Equity = $ 221,000 / $ 1,754,000 Operating Profit Margin Ratio = $ 418,000 / $ 3,074,000 Return on Common Equity = 12.6% Operating Profit Margin Ratio = 13.6% ROE measures the return earned on the common It measures the percentage of each sales peso stockholders’ investment in the firm. remaining after all costs and expenses (except for Generally, the owners are better off the higher interest, taxes, and preferred stock dividends) are the return. deducted. A higher operating profit margin is preferred. 15.0 MARKET FINANCIAL RATIOS 14.3 NET PROFIT MARGIN RATIO 15.1 PRICE-TO-EARNINGS PER SHARE RATIO *BASED ON THE FINANCIAL STATEMENTS ABOVE* Net Profit Margin Ratio = Net Profit / Total Revenue *BASED ON THE FINANCIAL STATEMENTS ABOVE* Net Profit Margin Ratio = $ 221,000 / $ 3,074,000 Assumption: If Bartlett Company’s Common Stock at the Net Profit Margin Ratio = 7.2% end of 2019 was selling at $ 32.35 Price-To-Earnings per Share Ratio = Market Price per Net Profit Margin is the percentage of revenue Share / Earnings per Share (EPS) remaining after all operating expenses, interest, Price-To-Earnings per Share Ratio = $ 32.35 / $ 2.90 taxes, and preferred stock dividends have been Price-To-Earnings per Share Ratio = 11.1 Times deducted from a company’s total revenue. The higher the firm’s net profit margin, the This figure indicates that investors were paying better. Look for a company with a growth of at 11.10 dollars for each 1-dolar earnings least 7% with no more than 2 years of declining PER measures the amount that investors are earnings of 5% during the past 10 years. willing to pay for each peso of a firm’s earnings. It answers how expensive the shares of stocks are. 14.4 EARNINGS PER SHARE A good rule of thumb for value investors is to *BASED ON THE FINANCIAL STATEMENTS ABOVE* look for stocks with a P/E less than 40% of the Earnings per Share = Earnings Available for Common stock’s highest P/E over the previous 5 years. Shareholders / Number of Common Stocks Outstanding Low P/E ratio could indicate the following: Earnings per Share = $ 221,000 / 76,262 Shares ○ Stagnant company’s growth Earnings per Share = $ 2.90 ○ The company is burdened with excessive debt It represents the amount earned on each ○ The stock could be undervalued outstanding share of common stocks and is an A company with a high P/E could be: important indicator of a company’s profitability ○ Overpriced and success. JUSTINE CONTRERAS, BSBA FM 4-5 6  FINANCIAL RATIO ANALYSIS AND FUNDAMENTAL ANALYSIS ○ Have dependable future earnings growth A higher figure signals that the company is doing brought on by recent expansion, well. It could signify a long-term investment as acquisition, or new product line—making companies' dividend policies are generally fixed it a good choice for growth investors. in the long run. A dividend yield that is at least ⅔ of the long-term AAA bond yield. Example, if the bond 15.2 PRICE-TO-EARNINGS GROWTH RATIO yield is 6%, the company’s dividend yield should *BASED ON THE FINANCIAL STATEMENTS ABOVE* be at least 4%. Price-To-Earnings Growth Ratio = P/E Ratio / EPS Growth Rate 15.6 DIVIDEND PAY-OUT RATIO Price-To-Earnings Growth Ratio = 11.1 Times / 60% Price-To-Earnings Growth Ratio = 0.18 *BASED ON THE FINANCIAL STATEMENTS ABOVE* Dividend Pay-Out Ratio = Dividend per Share / Earnings This ratio is used to determine a stock’s value per Share while considering a company’s earnings growth. Dividend Pay-Out Ratio = $ 1.29 / $ 2.90 Look for PEG ratios below 1. It indicates that the Dividend Pay-Out Ratio = 44% stock may be undervalued. A PEG ratio of more than 1 could imply that a stock is too expensive. Payout ratio is to measure the percentage of earnings given out as dividends. A company has two things to do with their 15.3 BOOK VALUE PER SHARE earnings: *BASED ON THE FINANCIAL STATEMENTS ABOVE* ○ To distribute dividends Book Value per Share = Common Stock Equity / No. of ○ To retain earnings Common Shares Outstanding Book Value per Share = ($ 191,000 + $ 428,000 + $ LIMITATIONS OF FINANCIAL RATIOS: 1,135,000) / 76, 262 Shares 16.0 CAUTIONARY CONSIDERATIONS Book Value per Share = $ 1,754,000 / 76, 262 Shares Book Value per Share = $ 23.00 Book Value per Share is also known as Intrinsic 16.1 INFLATION Value. While recording financial statements, companies do not Book Value is used to find high-growth consider inflation, which can produce uncertain companies that are undervalued. conclusions. Thus, analysts should adjust the data as per Generally, the higher the book value, the better. inflation when analyzing ratios. Look for a share price that’s no more than ⅔ of intrinsic value. If the market value is $ 32.25, the share price should be no more than $ 21.50. 16.2 ANALYTICAL KNOWLEDGE While examining companies and their financial 15.4 MARKET-TO-BOOK RATIO statements, one needs to have appropriate analytical skills. Without the knowledge of quantitative analysis, *BASED ON THE FINANCIAL STATEMENTS ABOVE* one is prone to frequent errors. Market-To-Book Ratio = Market Price per Share of Common Stock / Book value per Share of Common Stock Market-To-Book Ratio = $ 32.25 / $ 23.00 16.3 RELIABLE DATA Market-To-Book Ratio = 1.40 Times Using out-of-date historical values may forecast inaccurate performance. Sometimes, even the latest This figure indicates that investors are currently financial documents can be tampered with. Thus, the paying $ 1.40 for each $ 1.00 of book value of the data can be unreliable. company’s stock. MB Ratio provides an assessment of how investors view the firm’s performance. 16.4 ACCOUNTING POLICIES A low MB Ratio is a sign that the stock is Accounting policies differ from different industries, in undervalued. Value investors seek companies companies within the same industry, and even when a with MB Ratio that falls below industry averages. company changes its policies over years. Thus, we cannot Undervalued Stocks: Book Value > Market Value compare the ratio analysis results. 15.5 DIVIDEND YIELD RATIO 16.5 INTERPRETATION *BASED ON THE FINANCIAL STATEMENTS ABOVE* With different definitions of profits and valuation Assumption: If Bartlett Company’s Common Stock at the methods, we cannot compare companies enforcing end of 2019 was selling at $ 32.35 differing concepts. Seasonal effects can also result in Dividend Yield Ratio = Dividend per Share / Market Price inefficient analytical outcomes. Dividend Yield Ratio = $ 1.29 / $ 32.25 Dividend Yield Ratio = 4% JUSTINE CONTRERAS, BSBA FM 4-5 7  FINANCIAL RATIO ANALYSIS AND FUNDAMENTAL ANALYSIS FUNDAMENTAL ANALYSIS 5.0 ECONOMIC ANALYSIS Economic analysis occupies the first place in the financial analysis top-down approach. When the economy has 1.0 OBJECTIVES sustainable growth, then the industry groups (sectors) Identify the factors that are likely to affect the and companies will benefit and grow faster. Analyzing the value of an underlying asset. macroeconomic environment is essential to Evaluate a security to measure its intrinsic value, understanding the behavior of stock prices. by examining related economic, financial, and other qualitative and quantitative factors. The commonly analyzed macroeconomic factors Assess the expectations of market participants. are as follows: 2.0 FUNDAMENTAL ANALYSIS 5.1 GROSS DOMESTIC PRODUCT (GDP) Fundamental analysis is used to determine the share’s GDP indicates the rate of growth of the economy. GDP intrinsic value by examining the underlying forces that represents the value of all the goods and services affect the well-being of the economy, industry, groups, produced by a country in one year. The higher the growth and companies. Fundamental analysis is to first analyze rate is more favorable to the share market. the economy, then the industry and finally individual companies. This is called a top-down approach. 5.2 SAVINGS AND INVESTMENT The economic growth results in a substantial amount of 3.0 INTRINSIC VALUE domestic savings. The stock market is a channel through The actual value of a security, as opposed to its which the savings of the investors are made available to market price or book value. the industries. The savings and investment pattern of the It includes other variables such as brand name, public affect the stock market. Higher saving and trademarks, and copyrights that are often investment, other things being equal, is more favorable difficult to calculate and sometimes not for stock markets. accurately reflected in the market price. One way to look at it is that the market 5.3 INFLATION capitalization is the price (i.e. what investors are willing to pay for the company) and intrinsic It is a sustained increase in the general price level of value is the value (i.e. what the company is really goods and services in an economy over a period of time. worth). When the price level rises, each unit of currency buys fewer goods and services. Inflation impacts the capital market in numerous ways: TOP DOWN APPROACH OF FUNDAMENTAL 4.0 ANALYSIS 1. It reduces the value of fixed-income securities. 2. Increases the uncertainty in the economy. 3. The cost of production increases and thus profits can also shrink for the businesses. 5.4 INTEREST RATES The interest rate affects the cost of financing to the firms. A decrease in interest rate implies a lower cost of finance for firms and more profitability. Interest rates keep on changing in an economy due to various reasons and can affect the stock market. Higher interest rates mean that the money becomes more expensive to borrow. To compensate for the higher interest costs, companies may have to cut back spending or lay off workers. Higher interest rates also mean that a company cannot borrow as much as it used to, and this has an adverse effect on company earnings. All of this adds up to a drop in the stock market. Falling interest rate, on the other hand, leads to a growing stock market. 5.5 BUDGET The budget is the annual financial statement of the government, which deals with expected revenues and expenditures. A deficit budget may lead to a high rate of inflation and adversely affect the cost of production. The JUSTINE CONTRERAS, BSBA FM 4-5 8  FINANCIAL RATIO ANALYSIS AND FUNDAMENTAL ANALYSIS surplus budget may result in deflation. Hence, a balanced Economic forecasting is the prediction of any of the budget is highly favorable to the stock market. elements of economic activity. In any case, they describe the expected future behavior of all or part of the economy and help from the basis of economic analysis in 5.6 FISCAL AND MONETARY POLICIES investment. The collection of revenue and payment of expenditure by the government is called fiscal policies. Policy Over the years, it has become necessary for an investor to incorporating the actions of the central bank to control forecast the stock market trend. It helps investors in the money supply in the economy is called monetary taking the decision at the right time in order to maximize policy. There are various elements of fiscal and monetary its returns. policy that may have a favorable or unfavorable impact on the economy. These elements can be: 6.1 SURVEYS 1. Nature of budget One of the methods of short-term forecasting is to survey 2. Balance of payment position the type of business that one is interested in. The method 3. Tax structure to do this is approximate because it is based on the 4. Money supply beliefs, intentions, and future budgeting of the 5. And other elements government. The method to forecast through surveys is either through personal contact or a questionnaire. Personal contact is to meet the people and to record 5.7 MONSOON AND AGRICULTURE conversations about their intention to invest money by The Philippines is primarily an agricultural country. The type of product, and by type of industry in the future, and importance of agriculture in the Philippine economy is make an analysis of it. The other method of survey is evident. Agriculture is directly and indirectly linked with through the means of a detailed questionnaire which the industries. For example, sugar, textile, and food may either be filled in by meeting people personally or processing industries depend upon agriculture for raw the respondent may fill the form himself. The basic use of materials. Fertilizer and tractor industries are supplying this method is to have insight of the kind of activity in the input to agriculture. A good monsoon leads to better economy. These surveys may be based on statistical harvesting; this in turn improves the performance of the sample methods but after processing and tabulation of Philippines' economy. these questionnaires an analysis should be made. The limitation of this form of forecasting is that it is based on the observations of a particular person and on an 5.8 INFRASTRUCTURE intention of the future. The intention may not be carried Infrastructure facilities are essential for the growth of the into reality by the respondents. industrial and agricultural sector. Infrastructure facilities include transport, energy, banking, and communication. 6.2 BAROMETRIC INDICATORS The second approach behaves like a barometer. It 5.9 DEMOGRAPHIC FACTORS indicates the economic process through cyclical timings. Infrastructural facilities are regarded as the backbone of This method helps in finding out the leading, lagging, and an economy. Well-established connectivity through coincident indicators of economic activity. Although a robust transportation facilities is of paramount very accurate estimate is not possible, the barometers importance for any economy to develop. A good network indicate the level of economic activity. Three types of of communication systems in the form of indicators are: telecommunication facilities is also required to enhance the overall growth of an economy. Proper infrastructural 1. LEADING INDICATORS facilities along with communication networks also attract These are indicators that usually, but not always, change foreign direct investments. Therefore, good before the economy as a whole changes. They experience infrastructural facilities are the indicator of economic troughs and peaks before the troughs and peaks of the growth. economy. 2. LAGGING INDICATORS 5.10 POLITICAL STABILITY They experience troughs and peaks after those of the The political environment of a country has an impact on economy. the economic environment of the economy. A stable political scenario boosts up the investor’s confidence and 3. COINCIDENT INDICATORS on the other hand, a destabilized political system creates Their troughs and peaks roughly coincide with the an atmosphere of uncertainties in the mind of investors. troughs and peaks of the economy. The investor thus shall keep in the mind the current state of the economic-political environment of the economy. 6.3 DIFFUSION INDEXES 6.0 ECONOMIC FORECAST MODELS The diffusion index is a method that combines the different indicators into one total measure and it gives JUSTINE CONTRERAS, BSBA FM 4-5 9  FINANCIAL RATIO ANALYSIS AND FUNDAMENTAL ANALYSIS weaknesses and strengths of a particular time series of When data has been taken of all these sectors, these are data. The diffusion index is also called a census or a added up to get the forecast for the Gross National composite index. The method adapted in this Product. They are then tested for consistency. This economic reading of the future, is to take the leading, the method is very reliable and it is often used for forecasting coincidental, and the lagging factors together to the economic conditions of an economy. summarize them and then to draw out and infer a particular composite answer. 7.0 INDUSTRY ANALYSIS This is a complex statistical method and the combination The second step in the fundamental analysis of securities of various factors in this technique makes it extremely is industry analysis. An industry or sector is a group of difficult to draw out a proper understanding of the firms that have similar technological structures of forecasting methods. production and produce similar products. These industries are classified according to their reactions to the different phases of the business cycle. They are classified 6.4 ECONOMIC MODEL BUILDING into growth, cyclical, defensive, and cyclical growth This is a mathematical and statistical application to industries. A market assessment tool designed to provide forecast the future trends of the economy. This technique a business with an idea of the complexity of a particular can be used by trained technicians and it is used to draw industry. Industry analysis involves reviewing the out relationships between two or more variables. economic, political, and market factors that influence the way the industry develops. Major factors can include the This is a process technique as it specifies a particular power wielded by suppliers and buyers, the condition of system and calculates the results through simultaneous competitors and the likelihood of new market entrants. equations taking both endogenous variables and exogenous variables. The endogenous variables 7.1 INDUSTRY LIFE CYCLE ANALYSIS are usually predetermined and one equation is usually needed to find out the forecast value of the endogenous variables. 1. PIONEERING STAGE During this stage, the technology and product is relatively The advantage of this method is the precise nature of the new. The prospective demand for the product is answers and the accuracy in the forecast made. This promising in this industry. The demand for the product system may be applied in those advanced economics attracts many producers to produce the particular where the facilities of a computer are not difficult to product. This leads to severe competition and only fittest arrange for. companies survive in this stage. The producers try to develop brand names, differentiate the product, and 6.5 OPPORTUNISTIC MODEL BUILDING create a product image. This would lead to non-price competition too. The severe competition often leads to This method is the most widely used economic change of position of the firms in terms of market share forecasting method. This is also called sectoral and profit. analysis of the Gross National Product Model Building. This method uses the national accounting data 2. RAPID GROWTH STAGE to be able to forecast for a future short-term period. It is a This stage starts with the appearance of surviving firms flexible and reliable method of forecasting. from the pioneering stage. The companies that beat the competition grow strongly in sales, market share, and The method of forecasting is to find out the total income financial performance. The improved technology of and the total demand for the forecast period. To this are production leads to low cost and good quality of products. added the environment conditions of political stability, Companies with rapid growth in this stage, declare economic, and fiscal policies of the government, policies dividends during this stage. It is always advisable to relating to tax and interest rates. invest in these companies. GNP is calculated by taking the following sectors: 3. MATURITY AND STABILIZATION STAGE The forecast has to be broken down first by an After enjoying above-average growth, the industry now estimate of the government sector which is to be enters in the maturity and stabilization stage. The divided again into State Government and Central symptoms of technology obsolescence may appear. To Government expenses. keep going, technological innovation in the production The gross private domestic investment is to be process should be introduced. Close monitoring at calculated by adding the business expenses for industry events is necessary at this stage. plan, construction, and equipment changes in the level of business. 4. DECLINE STAGE The third sector which is to be taken is the The industry enters the growth stage with satiation of consumption sector relating to the personal demand, encroachment of new products, and change in consumption factor. This sector is usually divided consumer preferences. At this stage, the earnings of the into components of durable goods, non-durable industry have started declining. In this stage, the growth goods and services. of industry is low even in boom periods and declines at a JUSTINE CONTRERAS, BSBA FM 4-5 10  FINANCIAL RATIO ANALYSIS AND FUNDAMENTAL ANALYSIS higher rate during recession. It is always advisable not to The price-performance trade-off offered by the invest in the share of a low growth industry. substitute products is attractive. The switching costs for prospective buyers are minimal. 7.2 INDUSTRY’S COMPETITIVENESS The substitute products are being produced by In order to assess the level of competition in an industry, industries earning superior profits. Porter’s Five Forces Model is applied. Michael Porter (1985) provided a framework for analyzing the 4. BARGAINING POWER OF BUYERS competitive conditions prevailing in an industry and its Buyer is a competitive force. They can bargain for price relation with the industry’s profitability. In his model, cuts, ask for superior quality and better services, and Porter has identified five competitive forces that induce rivalry among competitors. If they are powerful, altogether can drive competition or determine the profit they can depress the profitability of the supplier industry. potential or strength of an industry. The forces identified The bargaining power of a buyer group is high when: by Porter in his study include: Its purchases are large relative to the sales of the 1. THREAT OF NEW ENTRANTS seller. New entrants add capacity, inflate costs, push prices Its switching costs are low. down, and reduce profitability. Hence, if an industry It poses a strong threat of backward integration. faces the threat of new entrants, its profit potential would be limited. 5. BARGAINING POWER OF SUPPLIERS Suppliers, like buyers, can exert a competitive force in an The threat of new entrants is low if the entry barriers industry as they can raise prices, lower quality, and confer an advantage on existing firms and deter new critical the range of free services they provide. Powerful entrants, Entry barriers are high when: suppliers can hurt the profitability of the buyer industry. Suppliers have strong bargaining power when: The new entrants have to invest substantial resources to enter the industry. Few suppliers dominate and the supplier group is Economies of scale are enjoyed by the industry. more concentrated than the buyer group. The government policy limits or even prevents There are hardly any viable substitutes for the new entrants. products supplied. Existing firms control the distribution channels, The switching costs for the buyers are high. benefit from product differentiation in the form Suppliers do present a real threat of forward of brand image and customer loyalty and enjoy integration. some kind of proprietary experience curve. 2. RIVALRY AMONG THE EXISTING FIRMS 8.0 COMPANY ANALYSIS Firms in an industry compete based on price, quality, Company analysis is a study of variables that influence promotion service, warranties, etc. If the rivalry between the future of a firm both qualitatively and quantitatively. the firms in an industry is strong, competitive moves and It is a method of assessing the competitive position of a countermoves dampen the average profitability of the firm, its earnings and profitability, the efficiency with industry. The intensity of rivalry in an industry tends to which it operates its financial position, and its future with be high when: respect to the earnings of its shareholders. Company analysis is the final stage of fundamental analysis. The number of competitors in the industry is large. In company analysis, the analyst tries to forecast the At least a few firms are relatively balanced and future earnings of the company because there is strong capable of engaging in a sustained competitive evidence that the earnings have a direct and powerful battle. effect on share prices. The level, trend, and stability of The industry growth is sluggish, prodding firms earnings of a company, however, depend upon a number to strive for a higher market share. of factors concerning the operations of the company. The industry confronts high exit barriers. The industry’s product is regarded as a The fundamental nature of the analysis is that each share commodity or near-commodity, stimulating of a company has an intrinsic value which is dependent strong price and service competition. on the company's financial performance. If the market value of a share is lower than intrinsic value as evaluated 3. PRESSURE FROM SUBSTITUTE PRODUCTS by fundamental analysis, then the share is supposed to be All the firms in an industry face competition from undervalued. The basic approach is analyzed through the industries producing substitute products. The substitute financial statements of an organization. goods may limit the profit potential of the industry by imposing a ceiling on the prices that can be charged by The company or corporate analysis is to be carried out to the firms in the industry. The threat from substitute get answers to the following two questions: products is high when: JUSTINE CONTRERAS, BSBA FM 4-5 11  FINANCIAL RATIO ANALYSIS AND FUNDAMENTAL ANALYSIS 1. How has the company performed in comparison management is employing the company’s with the similar company in the same industry? total assets to make a profit. The higher 2. How has the company performed in comparison the return, the more efficient to the early years? management is in utilizing its asset base. Before making an investment decision, the business plan Return on Assets = Net Income / of the company, management, annual report, financial Average Total Assets statements, cash flow, and ratios are to be examined for better returns. b. Return on Equity - This ratio indicates how profitable a company is by Company analysis can be studied under two heads: comparing its net income to its average shareholders’ equity. 8.1 FINANCIAL INDICATORS Return on Equity = Net Income / The investor shall conduct an in-depth analysis of the Average Shareholders’ Equity financial health of the selected company. A financially strong company can indicate good future returns. 3. Leverage Ratios - These ratios give investors a Financial analysis can be done through various tools. general idea of the company’s overall debt load as These can be: well as its mix of equity and debt. Debt ratios can be used to determine the overall level of financial A. RATIO ANALYSIS risk a company and its shareholders face. Some Financial ratios are mathematical calculations using of these ratios are: figures mainly from the financial statements, and they are used to gain an idea of a company’s valuation and a. Debt Ratios - It compares a company’s financial performance. Each valuation ratio uses different total debt to its total assets, which is used measures in its calculations. Investors might use different to gain a general idea as to the amount of ratios depending upon their requirement. leverage being used by a company. A low percentage means that the company is 1. Liquidity Ratios - Liquidity ratios measure a less dependent on leverage. company’s ability to pay off its short-term debt obligations. This is done by comparing a Debt Ratio = Total Liabilities / company’s most liquid assets to its short-term Total Assets liabilities. Some of the liquidity ratios are: b. Debt-To-Equity Ratio - Compares a a. Current Ratio - Ascertain whether a company's total liabilities to its total company’s short-term assets (cash, cash shareholders’ equity. This is a equivalents, marketable securities, measurement of how much suppliers, receivables, and inventory) are readily lenders, creditors, and obligors have available to pay off its short-term committed to the company versus what liabilities. the shareholders have committed. Current Ratio = Current Assets / Debt-To-Equity Ratio = Total Current Liabilities Liabilities / Shareholders’ Equity b. Quick Ratio - The quick ratio is more B. INCOME STATEMENT ANALYSIS conservative than the current ratio When it comes to analyzing fundamentals, the income because it excludes inventory and other statement lets investors know how well the company’s current assets, which are more difficult business is performing—or, basically, whether or not the to turn into cash. company is making money. Generally speaking, companies ought to be able to bring in more money than Quick Ratio = Cash Equivalents + they spend or they won't stay in business for long. Those Short-Term Investments + companies with low expenses relative to revenue—or high Accounts Receivable / Current profits relative to revenue—signal strong fundamentals to Liabilities investors. 2. Profitability Indicator - These ratios give C. BALANCE SHEET ANALYSIS users a good understanding of how well the The balance sheet highlights the financial condition of a company utilized its resources to generate profit company and is an integral part of the financial and shareholder value. Some of these ratios are: statements. It is also known as the statement of financial condition and offers a snapshot of a a. Return on Assets - This ratio indicates company’s health. It tells you how much a company owns how profitable a company is relative to (its assets), and how much it owes (its liabilities). The its total assets. The return on assets difference between what it owns and what it owes is its (ROA) ratio illustrates how well JUSTINE CONTRERAS, BSBA FM 4-5 12  FINANCIAL RATIO ANALYSIS AND FUNDAMENTAL ANALYSIS equity, also commonly called “net assets” or “shareholders equity”. The balance sheet tells investors a lot about a company’s fundamentals: how much debt the company has, how much it needs to collect from customers (and how fast it does so), how much cash and equivalents it possesses, and what kinds of funds the company has generated over time. Three major components of balance sheet analysis are: 1. Assets 2. Liabilities 3. Owner’s Equity D. CASH FLOW STATEMENT ANALYSIS The cash flow statement shows how much cash comes in and goes out of the company over the quarter or the year. Because it shows how much actual cash a company has generated, the statement of cash flows is critical to understanding a company’s fundamentals. It shows how the company is able to pay for its operations and future growth. 8.2 NON-FINANCIAL INDICATORS A. NATURE OF BUSINESS Even before an investor looks at a company’s financial statements or does any research, one of the most important questions that should be asked is, “What exactly does the company do?” This is referred to as a company’s business model—it’s how a company makes money. B. COMPETITIVE ADVANTAGE Another business consideration for investors is competitive advantage. A company’s long-term success is driven largely by its ability to maintain a competitive advantage—and keep it. C. MANAGEMENT A company relies upon management to steer it towards financial success. Some believe that management is the most important aspect for investing in a company. It makes sense—even the best business model is doomed if the leaders of the company fail to properly execute the plan. D. CORPORATE GOVERNANCE Corporate governance describes the policies in place within an organization denoting the relationships and responsibilities between management, directors and stakeholders. These policies are defined and determined in the company charter and its bylaws, along with corporate laws and regulations. The purpose of corporate governance policies is to ensure that proper checks and balances are in place, making it more difficult for anyone to conduct unethical and illegal activities. JUSTINE CONTRERAS, BSBA FM 4-5 13 CAPITAL MARKET FIMA 30083: WEEK 13-15 TECHNICAL ANALYSIS to analyze markets using hourly, 4-hour, daily, or even 1.0 TECHNICAL ANALYSIS weekly charts. Technical analysis is a tool, or method, used to predict the probable future price movement of a security—such Price movement that occurs within a 15-minute time span as a stock or currency pair—based on market data. may be very significant for an intra-day trader who is looking for an opportunity to realize a profit from price The theory behind the validity of technical analysis is the fluctuations occurring during one trading day. However, notion that the collective actions—buying and selling—of that same price movement viewed on a daily or weekly all the participants in the market accurately reflect all chart may not be particularly significant or indicative for relevant information pertaining to a traded security, and long-term trading purposes. therefore, continually assign a fair market value to the security. It’s simple to illustrate this by viewing the same price action on different time frame charts. The following daily chart for silver shows price trading within the same PAST PRICE AS INDICATOR OF FUTURE range, from roughly $ 16 to $ 18.50, that it’s been in for 2.0 PERFORMANCE the past several months. A long-term silver investor Technical traders believe that current or past price action might be inclined to look to buy silver based on the fact in the market is the most reliable indicator of future price that the price is fairly near the low of that range. action. However, the same price action viewed on an hourly Technical analysis is not only used by technical traders. chart (below) shows a steady downtrend that has Many fundamental traders use fundamental analysis to accelerated somewhat just within the past several hours. determine whether to buy into a market, but having made A silver investor interested only in making an intra-day that decision, then use technical analysis to pinpoint trade would likely shy away from buying the precious good, low-risk buy entry price levels. metal based on the hourly chart price action. 3.0 CHARTING ON DIFFERENT TIME FRAMES 4.0 CANDLESTICKS Technical traders analyze price charts to attempt to Candlestick charting is the most commonly used method predict price movement. The two primary variables for of showing price movement on a chart. A candlestick is technical analysis are the time frames considered and formed from the price action during a single time period the particular technical indicators that a trader for any time frame. Each candlestick on an hourly chart chooses to utilize. shows the price action for one hour, while each candlestick on a 4-hour chart shows the price action The technical analysis time frames shown on charts range during each 4-hour time period. from one-minute to monthly, or even yearly, time spans. Popular time frames that technical analysts most Candlesticks are “drawn” / formed as follows: The frequently examine include: highest point of a candlestick shows the highest price security traded at during that time period, and the 5-minute chart lowest point of the candlestick indicates the lowest 15-minute chart price during that time. The “body” of a candlestick Hourly chart (the respective red or blue “blocks”, or thicker parts, of 4-hour chart each candlestick as shown in the charts above) indicates Daily chart the opening and closing prices for the time period. If a blue candlestick body is formed, this indicates that the The time frame a trader selects to study is typically closing price (top of the candlestick body) was higher determined by that individual trader’s personal than the opening price (bottom of the candlestick trading style. Intra-day Traders, traders who open body); conversely, if a red candlestick body is formed, and close trading positions within a single trading day, then the opening price was higher than the closing favor analyzing price movement on shorter time frame price. charts, such as the 5-minute or 15-minute charts. Candlestick colors are arbitrary choices. Some traders use Long-term Traders who hold market positions white and black candlestick bodies (this is the default overnight and for long periods of time are more inclined color format, and therefore the one most commonly used); other traders may choose to use green and red, or JUSTINE CONTRERAS, BSBA FM 4-5 1  TECHNICAL ANALYSIS blue and yellow. Whatever colors are chosen, they strong rejection of an attempt to push market prices provide an easy way to determine at a glance whether higher and thereby suggests a potential downside reversal price closed higher or lower at the end of a given time may follow. period. Technical analysis using a candlestick chart is often easier than using a standard bar chart, as the The rare, four price doji, where the market opens, analyst receives more visual cues and patterns. closes, and in-between conducts all buying and selling at the exact same price throughout the time period, is the epitome of indecision, a market that shows no inclination 4.1 CANDLESTICK PATTERNS - DOJIS to go anywhere in particular. Candlestick patterns, which are formed by either a single candlestick or by a succession of two or three There are dozens of different candlestick formations, candlesticks, are some of the most widely used technical along with several pattern variations. Probably the most indicators for identifying potential market reversals or complete resource for identifying and utilizing trend changes. candlestick patterns is Thomas Bulkowski’s pattern site, which thoroughly explains each candlestick pattern Doji candlesticks, for example, indicate indecision in a and even provides statistics on how often each pattern market that may be a signal for an impending trend has historically given a reliable trading signal. It’s change or market reversal. The singular characteristic of certainly helpful to know what a candlestick pattern a doji candlestick is that the opening and closing prices indicates – but it’s even more helpful to know if that are the same, so the candlestick body is a flat line. The indication has proven to be accurate 80% of the time. longer the upper and/or lower “shadows”, or “tails”, on a doji candlestick – the part of the candlestick that 5.0 TECHNICAL INDICATORS indicates the low-to-high range for the time period – the stronger the indication of market indecision and potential reversal. 5.1 MOVING AVERAGES There are several variations of doji candlesticks, each Moving averages are probably the single most widely with its own distinctive name, as shown in the illustration used technical indicator. Many trading strategies utilize below. one or more moving averages. A simple moving average trading strategy might be something like, “Buy as long as price remains above the 50-period exponential moving average (EMA); Sell as long as price remains below the 50 EMA”. Moving average crossovers are another frequently employed technical indicator. A crossover trading strategy might be to buy when the 10-period moving average crosses above the 50-period moving average. The higher a moving average number is, the more significant price movement in relation to it is considered. For example, price crossing above or below a 100- or The typical doji is the long-legged doji, where the price 200-period moving average is usually considered much extends about equally in each direction, opening and more significant than price moving above or below a closing in the middle of the price range for the time 5-period moving average. period. The appearance of the candlestick gives a clear visual indication of indecision in the market. When a doji like this appears after an extended uptrend or downtrend 5.2 PIVOTS AND FIBONACCI NUMBERS in a market, it is commonly interpreted as signaling a possible market reversal, a trend change in the opposite direction. A. PIVOTS Daily pivot point indicators, which usually also identify The dragonfly doji, when appearing after a prolonged several support and resistance levels in addition to the downtrend, signals a possible upcoming reversal to the pivot point, are used by many traders to identify price upside. Examination of the price action indicated by the levels for entering or closing out trades. Pivot point levels dragonfly doji explains its logical interpretation. The often mark significant support or resistance levels or the dragonfly shows sellers pushing the price substantially levels where trading is contained within a range. If lower (the long lower tail), but at the end of the period, trading soars (or plummets) through the daily pivot and the price recovers to close at its highest point. The all the associated support or resistance levels, this is candlestick essentially indicates a rejection of the interpreted by many traders as “breakout” trading that extended push to the downside. will shift market prices substantially higher or lower, in the direction of the breakout. The gravestone doji’s name clearly hints that it represents bad news for buyers. The opposite of the Daily pivot points and their corresponding support and dragonfly formation, the gravestone doji indicates a resistance levels are calculated using the previous trading JUSTINE CONTRERAS, BSBA FM 4-5 2  TECHNICAL ANALYSIS day’s high, low, opening and closing prices. I’d show you move from $10 to $40 turns out to be the retracement the calculation, but there’s really no need, as pivot point low, then from that price ($31), you find the first levels are widely published each trading day and there are Fibonacci extension level and potential “take profit” pivot point indicators you can just load on a chart that do target by adding 126% of the original $30 move upward. the calculations for you and reveal pivot levels. Most The calculation goes as follows: pivot point indicators show the daily pivot point along with three support levels below the pivot point and three Fibonacci extension level of 126% = $ 31 + ($ 30 x 1.26) = price resistance levels above it. $ 68 – giving you a target price of $ 68. B. FIBONACCI NUMBERS Once again, you never actually have to do any of these Fibonacci levels are another popular technical analysis calculations. You just plug a Fibonacci indicator into your tool. Fibonacci was a 12th-century mathematician who charting software and it displays all the various Fibonacci developed a series of ratios that is very popular with levels. technical traders. Fibonacci ratios, or levels, are commonly used to pinpoint trading opportunities and Pivot and Fibonacci levels are worth tracking even if you both trade entry and profit targets that arise during don’t personally use them as indicators in your own sustained trends. trading strategy. Because so many traders do base buying and selling moves on pivot and Fibonacci levels, if The primary Fibonacci ratios are 0.24, 0.38, 0.62, and nothing else there is likely to be significant trading 0.76. These are often expressed as percentages – 23%, activity around those price points, activity that may help 38%, etc. Note that Fibonacci ratios complement other you better determine probable future price moves. Fibonacci ratios: 24% is the opposite, or remainder, of 76%, and 38% is the opposite, or remainder, of 62%. 5.3 MOMENTUM INDICATORS As with pivot point levels, there are numerous freely Moving averages and most other technical indicators are available technical indicators that will automatically primarily focused on determining likely market direction, calculate and load Fibonacci levels onto a chart. up or down. B.1 FIBONACCI RETRACEMENTS There is another class of technical indicators, however, Fibonacci Retracements are the most often used whose main purpose is not so much to determine market Fibonacci indicator. After a security has been in a direction as to determine market strength. These sustained uptrend or downtrend for some time, there is indicators include such popular tools as the Stochastic frequently a corrective retracement in the opposite Oscillator, the Relative Strength Index (RSI), the Moving direction before price resumes the overall long-term Average Convergence-Divergence (MACD) indicator, and trend. Fibonacci retracements are used to identify good, the Average Directional Movement Index (ADX). low-risk trade entry points during such a retracement. By measuring the strength of price movement, For example, assume that the price of stock “A” has momentum indicators help investors determine whether climbed steadily from $10 to $40. Then the stock price current price movement more l