Analysis of Stocks PDF

Analysis of Stocks NISHANT KUMAR Nishant Kumar ASSISTANT AssistantPROFESSOR Professor ARKAArka JAIN UNIVERSITY Jain University  Analysis of Stocks Fundamental Analysis Fundamental analysis (FA) measures a security's intrinsic v...

Analysis of Stocks NISHANT KUMAR Nishant Kumar ASSISTANT AssistantPROFESSOR Professor ARKAArka JAIN UNIVERSITY Jain University  Analysis of Stocks Fundamental Analysis Fundamental analysis (FA) measures a security's intrinsic value by examining related economic and financial factors. An investment's intrinsic value is determined by the financial health of the issuing company, as well as the general market and economic climate. Fundamental analysts look at all potential influences on a security's value, including microeconomic elements like managerial efficiency and macroeconomic factors like the status of the economy and marketcircumstances. Nishant Kumar Assistant Professor Arka Jain University  Points to Remember  Fundamental analysis is a method of determining a stock's real or "fair market" value.  Fundamental analysts search for stocks currently trading at prices higher or lower than their real value.  If the fair market value is higher than the market price, the stock is deemed undervalued, and a buyrecommendation is given.  If the fair market value is lower than the market price, the stock is deemed overvalued, and the recommendation might be not to buy or to sell if the stock is held.  In contrast, technical analysts favor studying the historical price trends of the stock to predict short-term future trends.  Fundamental analysis is usually done from a macro to micro perspective to identify securities that are not correctly priced by the market. Analysts typically study, in order.  The overall state of the economy  The strength of the specific industry  The financial performance of the company issuing the stock Intrinsic Value One of the primary assumptions behind fundamental analysis is A. stock's current price often does not fully reflect the value of the company when compared to publicly available financial data. B. A second assumption is that the value reflected from the company's fundamental data is more likely to be closer to the true value of the stock. For example, say that a company's stock was trading at 200, and after extensive research on the company, an analyst determines that it ought to be worth 240. Another analyst does equal research but decides it should be worth 260. Nishant Kumar Assistant Professor Arka Jain University  Many investors will consider the average of these estimates and assume that the stock's intrinsic value may be near 250. Often investors consider these estimates highly relevant because they want to buy stocks trading at prices significantly below these intrinsic values. This leads to a third major assumption of fundamental analysis: In the long run, the stock market will reflect the fundamentals. The problem is, no one knows how long "the long run" really is. It could be days or years. This is what fundamental analysis is all about. By focusing on a particular business, an investor can estimate the intrinsic value of a firm and find opportunities to buy at a discount or sell at a premium. The investment will pay off when the market catches up to the fundamentals. Quantitative and Qualitative Fundamental Analysis  Quantitative: information that can be shown using numbers, figures, ratios, or formulas  Qualitative: rather than a quantity of something, it is its quality, standard, or nature  Qualitative Fundamentals to Consider There are four key fundamentals that analysts always consider when regarding a company. All are qualitative rather than quantitative. They include: The Business Model What exactly does the company do? This isn't as straightforward as it seems. If a company's business model is based on selling fast-food chicken, is it making its money that way? Or is it just coasting on royalty and franchise fees? Competitive Advantage A company's long-term success is primarily driven by its ability to maintain a competitive advantage— and keep it. Powerful competitive advantages, such as Coca-Cola's brand name and Microsoft's domination of the personal computer operating system, create a moat around a business allowing it to keep competitors at bay and enjoy growth and profits. When a company can achieve a competitive advantage, its shareholders can be well rewarded for decades. Nishant Kumar Assistant Professor Arka Jain University  Management Some believe management is the most important criterion for investing in a company. It makes sense: Even the best business model is doomed if the company's leaders fail to execute the plan properly. While it's hard for retail investors to meet and truly evaluate managers, you can look at the corporate website and check the resumes of the top brass and the board members. How well did they perform in previous jobs? Have they been unloading a lot of their stock shares lately? 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, its bylaws, and corporate laws and regulations. You want to do business with a company that is run ethically, fairly, transparently, and efficiently. Particularly note whether management respects shareholder rights and shareholder interests. Make sure their communications to shareholders are transparent, clear, and understandable. If you don't get it, it's probably because they don't want you to. Industry It's also important to consider a company's industry: its customer base, market share among firms, industry-wide growth, competition, regulation, and business cycles. Learning how the industry works will give an investor a deeper understanding of a company's financial health.  Quantitative Fundamentals to Consider: Financial Statements Financial statements are the medium by which a company discloses information concerning its financial performance. Followers of fundamental analysis use quantitative information from financial statements to make investment decisions. The three most important financial statements are income statements, balance sheets, and cash flow statements. Nishant Kumar Assistant Professor Arka Jain University  The Balance Sheet The balance sheet represents a record of a company's assets, liabilities, and equity at a particular point in time. It is called a balance sheet because the three sections— assets, liabilities, and shareholders' equity— must balance using the formula: Assets = Liabilities + Shareholders' Equity Assets represent the resources the business owns or controls at a given time. This includes items such as cash, inventory, machinery, and buildings. The other side of the equation represents the total financing value the company has used to acquire those assets. Financing comes as a result of liabilities or equity. Liabilities represent debts or obligations that must be paid. In contrast, equity represents the total value of money that the owners have contributed to the business—including retained earnings, which is the profit left after paying all current obligations, dividends, and taxes. The Income Statement While the balance sheet takes a snapshot approach in examining a business, the income statement measures a company's performance over a specific time frame. Technically, you could have a balance sheet for a month or even a day, but you'll only see public companies report quarterly and annually. The income statement presents revenues, expenses, and profit generated from the business' operations for that period. Statement of Cash Flows The statement of cash flows represents a record of a business' cash inflows and outflows over a period of time. Typically, a statement of cash flows focuses on the following cash-related activities:  Cash from investing (CFI): Cash used for investing in assets, as well as the proceeds from thesale of other businesses, equipment, or long-term assets  Cash from financing (CFF): Cash paid or received from the issuing and borrowing of funds  Operating Cash Flow (OCF): Cash generated from day-to-day business operations Nishant Kumar Assistant Professor Arka Jain University  Technical Analysis Technical Analysis can be defined as an art and science of forecasting future prices based on an examination of the past price movements. Technical analysis is not astrology for predicting prices. Technical analysis is based on analyzing current demand-supply of commodities, stocks, indices, futures or any tradable instrument. Technical analysis involves putting stock information like prices, volumes and open interest on a chart and applying various patterns and indicators to it in order to assess the future price movements. The time frame in which technical analysis is applied may range from intraday (1- minute, 5-minutes, 10-minutes, 15-minutes, 30-minutes or hourly), daily, weekly or monthly price data to many years. There are essentially two methods of analyzing investment opportunities in the security market viz fundamental analysis and technical analysis. You can use fundamental information like financial and non-financial aspects of the company or technical information which ignores fundamentals and focuses on actual price movements. Nishant Kumar Assistant Professor Arka Jain University  The basis of Technical Analysis (Dow Theory) What makes Technical Analysis an effective tool to analyze price behavior is explained by following principles given by Charles Dow:  Market discounts everything  Markets move in trends  Volume confirms the trend  Indices move in accordance with each other  Market trend has three phases.  There is no trend reversal without proper indication. Candlesticks Formation Candlestick charts provide visual insight to current market psychology. A candlestick displays the open, high, low, and closing prices in a format similar to a modern-day bar-chart, but in a manner that extenuates the relationship between the opening and closing prices. Candlesticks don’t involve any calculations. Each candlestick represents one period (e.g., day) of data. The figure given belowdisplays the elements of a candle. Nishant Kumar Assistant Professor Arka Jain University  A candlestick chart can be created using the data of high, low, open and closing prices for each time period that you want to display. The hollow or filled portion of the candlestick is called “the body” (also referred to as “the real body”). The long thin lines above and below the body represent the high/low range and are called “shadows” (also referred to as “wicks” and “tails”). The high is marked by the top of the upper shadow and the low by the bottom of the lower shadow. If the stock closes higher than its opening price, a hollow candlestick is drawn with the bottom of the body representing the opening price and the top of the body representing the closing price. If the stock closes lower than its opening price, a filled candlestick is drawn with the top of the body representing the opening price and the bottom of the body representing the closing price. Each candlestick provides an easy-to-decipher picture of price action. Immediately a trader can see and compare the relationship between the open and close as well as the high and low. The relationship between the open and close is considered vital information and forms the essence of candlesticks. Hollow candlesticks, where the close is greater than the open, indicate buying pressure. Filled candlesticks, where the close is less than the open, indicate selling pressure. Thus, compared to traditional bar charts, many traders consider candlestick charts more visually appealing and easier to interpret. Nishant Kumar Assistant Professor Arka Jain University  NIFTY (Daily) Candlestick Chart Why candlestick charts? What does candlestick charting offer that typical Western high-low bar charts do not? Instead of vertical line having horizontal ticks to identify open and close, candlesticks represent two dimensional bodies to depict open to close range and shadows to mark day’s high and low. For several years, the Japanese traders have been using candlestick charts to track market activity. Eastern analysts have identified a number of patterns to determine the continuation and reversal of trend. These patterns are the basis for Japanese candlestick chart analysis. This places candlesticks rightly as a part of technical analysis. Japanese candlesticks offer a quick picture into the psychology of short term trading, studying the effect, not the cause. Applying candlesticks means that for short-term, an investor can make confident decisions about buying, selling, or holding an investment. Nishant Kumar Assistant Professor Arka Jain University  Candlestick analysis One cannot ignore that investor’s psychologically driven forces of fear; greed and hope greatly influence the stock prices. The overall market psychology can be tracked through candlestick analysis. More than just a method of pattern recognition, candlestick analysis shows the interaction between buyers and sellers. A white candlestick indicates opening price of the session being below the closing price; and a black candlestick shows opening price of the session being above the closing price. The shadow at top and bottom indicates the high and low for the session. Japanese candlesticks offer a quick picture into the psychology of short term trading, studying the effect, not the cause. Therefore, if you combine candlestick analysis with other technical analysis tools, candlestick pattern analysis can be a very useful way to select entry and exit points. One candle patterns In the terminology of Japanese candlesticks, one candle patterns are known as “Umbrella lines”. There are two types of umbrella lines - the hanging man and the hammer. They have long lower shadows and small real bodies that are at top of the trading range for the session. They are the simplest lines because they do not necessarily have to be spotted in combination with other candles to have some validity. Hammer and Hanging Man Hammer Hanging Man Candlesticks Nishant Kumar Assistant Professor Arka Jain University  Hammer Hammer is a one candle pattern that occurs in a downtrend when bulls make a start to step into the rally. It is so named because it hammers out the bottom. The lower shadow of hammer is minimum of twice the length of body. Although, the color of the body is not of much significance but a white candle shows slightly more bullish implications than the black body. A positive day i.e. a white candle is required the next day to confirm this signal. Criteria 1. The lower shadow should be at least two times the length of the body. 2. There should be no upper shadow or a very small upper shadow. 3. The real body is at the upper end of the trading range. The color of the body is not important although a white body should have slightly more bullish implications. 4. The following day needs to confirm the Hammer signal with a strong bullish day. Signal enhancements 1. The longer the lower shadow, the higher the potential of a reversal occurring. 2. Large volume on the Hammer day increases the chances that a blow offday has occurred. 3. A gap down from the previous day’s close sets up for a stronger reversal move provided the day after the Hammer signal opens higher. Pattern psychology The market has been in a downtrend, so there is an air of bearishness. The price opens and starts to trade lower. However, the sell-off is abated and market returns to high for the day as the bulls have stepped in. They start bringing the price back up towards the top of the trading range. This creates a small body with a large lower shadow. This represents that the bears could not maintain control. The long lower shadow now has the bears questioning whether the decline is still intact. Confirmation would be a higher open with yet a still higher close onthe next trading day. Nishant Kumar Assistant Professor Arka Jain University  Hanging man The hanging man appears during an uptrend, and its real body can be either black or white. While it signifies a potential top reversal, it requires confirmation during the next trading session. The hanging man usually has little or no upper shadow. Fig: Soybean Oil-December, 1990, Daily (Hanging Man and Hammer) Nishant Kumar Assistant Professor Arka Jain University  Two candles pattern  Bullish engulfing A “bullish engulfing pattern” consists of a large white real body that engulfs a small blackreal body during a downtrend. It signifies that the buyers are overwhelming the sellers Engulfing Bullish engulfing Description The Engulfing pattern is a major reversal pattern comprised of two opposite colored bodies. This Bullish Pattern is formed after a downtrend. It is formed when a small black candlestick is followed by a large white candlestick that completely eclipses the previous day candlestick. It opens lower that the previous day’s close and closes higher than the previous day’s open. Criteria 1. The candlestick body of the previous day is completely overshadowed by the next day’s candlestick. 2. Prices have been declining definitely, even if it has been in short term. 3. The color of the first candle is similar to that of the previous one and the body of the second candle is opposite in color to that first candle. The only exception being an engulfed body which is a doji. Nishant Kumar Assistant Professor Arka Jain University  Pattern psychology After a decline has taken place, the price opens at a lower level than its previous day closing price. Before the close of the day, the buyers have taken over and have led to an increase in the price above the opening price of the previous day. The emotional psychology of the trendhas now been altered. When investors are learning the stock market they should utilize information that has workedwith high probability in the past. Bullish Engulfing signal if used after proper training and at proper locations, can lead to highly profitable trades and consistent results. This pattern allows an investor to improve their probabilities of been in a correct trade. The common sense elements conveyed in candlestick signals makes for a clear and concise trading technique for beginning investors as well as experienced traders. Bearish engulfing A “bearish engulfing pattern,” on the other hand, occurs when the sellers are overwhelming the buyers. This pattern consists of a small white candlestick with short shadows or tails followed by a large black candlestick that eclipses or “engulfs” the small white one. Bearish Engulfing Nishant Kumar Assistant Professor Arka Jain University  MACD ANALYSIS Nishant Kumar Assistant Professor Arka Jain University  Moving average convergence divergence (MACD, or MAC-D) is a trend- following momentum indicator that shows the relationship between two exponential moving averages (EMA's) of a security’s price. The MACD is calculated by subtracting the 26- period exponential moving average (EMA) from the 12-period EMA.  The MACD line is calculated by subtracting the 26-period exponential moving average (EMA) from the 12-period EMA. The MACD signal line is a 9 period EMA of the MACD line.  MACD is best used with daily periods, where the traditional settings of 26/12/9 daysis the norm.  The MACD triggers technical signals when the MACD line crosses above the signal line (to buy) or falls below (to sell) it.  MACD can help gauge whether a security is overbought or oversold, alerting traders to the strength of a directional move. Nishant Kumar Assistant Professor Arka Jain University  MACD can also alert investors to a bullish/bearish divergence (e.g., when a new high in price is not confirmed by a new high in the MACD, and vice versa), suggesting a potential failure and reversal.  After a signal line crossover, it is recommended to wait for 3-4 days to confirm that it is not a false move. Nishant Kumar Assistant Professor Arka Jain University