Updated: Jul 25, 2020
Investment is defined as an asset that is bought, which has the capability of generating wealth or appreciates over time. They are very important in today’s world, just earning money is not enough. You may work very hard to earn money but the question is, is your hard earned money adequate in today’s inflating economy? The answer is no, you need to make your money work for you by investing it.
If you ask a layman where to invest his money, he would say stock markets, a very common mode of investing money in today’s time with everything getting digitalized. But, people often get confused as to which approach to choose while investing in markets.
There are two ways one can decide his engagement in the market-
Let us know more about fundamental and technical analysis:-
Fundamental Analysis is a method of evaluating the intrinsic value of an asset and analyse the factors that could influence its price in the future. This form of analysis is based on external events and influences, as well as financial statements and industry trends.
Technical analysis is a means of examining and predicting price movements in the financial markets, by using historical price charts and market statistics. It is based on the idea that if a trader can identify previous market patterns, they can form a fairly accurate prediction of future price trajectories.
WHAT DO THEY INCLUDE?
Fundamentals include analyzing the financial statements, digging into them for any red flags, reviewing the management, listening to con-calls to know more about the future prospects.
While analyzing the financial statements, we calculate the key financial ratios like-Debt/Equity ratio, EPS, OPM, P/B ratio & many more. In addition to these key financial ratios, there are other tools to evaluate the company’s valuation, financial stability in the long term, and its fairness and soundness which I shall discuss later.
Technical analysis majorly focuses on price, volumes & trends. One looks at the past price-volume data on a chart to understand the trend and makes decisions accordingly.
Technical analysis is based on four assumptions-:
-The market discounts everything
-Price moves in trends
-History tends to repeat itself
To exemplify, “HISTORY REPEATS ITSELF”, the given picture shows how the stock price comes back to its support line (marked in blue) multiple times in 8 years.
Fundamental analysis includes using various tools to evaluate a company, some of which are:
Valuation- A business valuation is a general process of determining the “Economic Value” of a whole business or company unit. Valuation can be obtained using three different approaches – Market based approach, Asset based approach, Income based approach.
Financial Modeling- Financial modeling is the process of creating a summary of a company's expenses and earnings in the form of a spreadsheet that can be used to calculate the impact of a future event or decision.
MOAT Analysis- Popularized by Warren Buffett, it refers to a business's ability to maintain competitive advantages over its competitors to protect its long-term profits and market share from competing firms
There are various others as well like, Revenue drivers, Cost drivers, Michael Porter analysis, etc.
As discussed earlier, even technical analysis requires a helping hand from various tools to decide the next move. Here are a few of them:
Price patterns- A price pattern is a recognizable configuration of price movement that is identified using a series of trendlines and/or curves. When a price pattern signals a change in trend direction, it is known as a reversal pattern (e.g. Double bottom, Double top, Rounded bottom, Rounded top, Head & Shoulder, Inverse head & shoulder). A continuation pattern occurs when the trend continues in its existing direction (e.g. Triangle, Flag, Rectangle)
Candlestick patterns- A candlestick pattern is a movement in prices shown graphically on a candlestick chart that can predict a particular market movement. Candlesticks are useful when trading as they show four price points (open, close, high, and low) throughout the period of time the trader specifies. Some of candlestick pattern are (Doji, spinning (Top, Bottom), Island (Top, Bottom), Hammer, hanging man, Shooting star, etc.)
There are many other indicators like Fibonacci extension & retracement which tells the market participant the potential of the stock price to move up or down after the fall or rise previously, oscillators like RSI helps us to understand whether the stock is in an oversold or an overbought zone.
ENTRY & EXIT POINTS
As we all know, financial analysis is used to invest money for a long term.
Below is an example of how would an investor invest his money in a company called Bajaj Finance in the year 2017 at 760 and would exit in 2020 at 4923 making a profit of whooping 547% in 3 years. This is possible only if the investor does a fundamental analysis on this company and finds potential interest in it at that time.
Taking the same example as above, let us see how does a trader take position over a period of time.
Here the stock is in an uptrend and the candlesticks are forming higher highs and higher lows, hence a trader with help of the above-mentioned tools would enter and exit his positions in the stock as illustrated in the chart. This also points out the difference in time-frame of these two methods which are at two ends of the spectrum.
Both the above approaches will help an investor make a prudent decision. However, this will largely depend on an individual's nature, risk appetite, faith in either of the methods etc. One has to honestly recognize one's bent of mind and stick on to that choice throughout the analysis process.