fundamental and technical analysis - technical paper

8/10/2019 Fundamental and Technical Analysis - Technical Paper

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FUNDAMENTAL ANDTECHNICAL ANALYSIS

OF STOCK MARKETSNational Convention for CA Students Mumbai

Technical Session 1

Investment Opportunities

2013

GAURI SHRIPAD ARAVKAR

VIVEK DOSHI & CO


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Fundamental and Technical Analysis of Stock Markets

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Contents

Stock ValuationMeaning and Methods of Valuation.................................................................... 3

Fundamental Vs. Technical AnalysisBirds Eye view..................................................................... 4

Role of Fundamental and Technical Analysis in Determining Stock Price ....................................... 5

Methodology used in Fundamental Analysis.................................................................................... 6

Methodology used in Technical Analysis.......................................................................................... 7

Balanced Application of both analysis necessary........................................................................... 13

Case Study: Failure of Analysis in the light of Stock Manipulation................................................ 14

References........................................................................................................................................ 16


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Stock Valuation Meaning and Methods of Valuation

Stock valuation is the method of calculating the theoretical worth of a companysstock and thus that of the Company. The need of stock valuation arises for

variety of financial decisions few of which are listed below:

1. Investment Analysis2. Capital Budgeting3. Merger and Acquisition4. Financial Reporting5. Determining Tax Liability6. Litigation

However, this paper focuses on the valuation of stock markets for facilitating theinvestment decisions so as to make maximum profit.

The stock market is like a flea market where people buy & sell pieces of papercalled stock. There are owners of the corporations who want to raise money tohire more employees, build factories or offices. They raise money by issuingshares of stock in their corporation. On the other side, there are investors whobuy shares of stock in the corporation. The place both sides meet is the stockmarket.

There are two basic methods for determining what stock to buy and sell -Fundamental Analysis and Technical Analysis.


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Fundamental Vs. Technical Analysis Birds Eye view

In a shopping mall, a fundamental analyst would go to each store, study theproduct that was being sold, and then decide whether to buy it or not. By

contrast, a technical analyst would sit on a bench in the mall and watch peoplego into the stores. Disregarding the intrinsic value of the products in the store,the technical analyst's decision would be based on the patterns or activity ofpeople going into each store.

Fundamental

Analysis

Financial Position

Balance Sheet

Financial Performance

Profit & Loss AccountRatio Analysis

Technical

Analysis

Chart and Trend

Analysis

Dow Theory

Past Prices andVolume

Moving Average,Support and

Resistance,RelativeStrength Index


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Role of Fundamental and Technical Analysis in Determining

Stock Price

Fundamental analysis as it name signifies analysis of fundamentals of company

and economy analysis. Balance sheet is the back bone of a company. A good

company has strong balance sheet and fundamental analyst try to find the

intrinsic value of company by analyzing the balance sheet, Growth rate, Profit

and loss, Cash flow, Industry analysis and economic analysis. So in nut shell a

good company has high growth rate, low leverage, good management, and Low

P/E ratio compared with peers, Low debt-Equity Ratio.

Fundamental analysis is good for investment but main problem with fundamental

analysis is Difficulty in getting in depth information of company, lot of resource

is required for fundamental analysis and for most investor it is out of their hand,

unavailability of hidden news and difficulty to judge the companys valuation etc.

Here comes the importance of technical analysis.

Technical analyst uses the demand supply theory to judge the price and they

believe past price movement will have an impact on future movement also.

Share price increase or decrease whenever there is a change in fundamental and

it will be reflected in its demand/supply and in turn it will affect the price. So

technical analyst uses historical price/volume to judge the future price

movement of stock. He uses charting software and uses various tools like

moving average, oscillator to find the support level - share price at which thereis demand for share-Buy will occur and resistance level - share price at which

supply will occur-sell happens of share.


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Methodology used in Fundamental Analysis

Economy Indicators

Social Indicators

Investment Scenario

Stock market Analysis

Sovereign Rating

EconomyAnalysis

Size and Dynamics

Industry Life Cycle

Demand Drivers

External Factors

Future Outlook

IndustryAnalysis

Competitive Position

Distinctive Edge

Segmental AnalysisFinancial Analysis

Growth Prospects

Company

Analysis


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Methodology used in Technical Analysis

Technical Analysis is based on the following assumptions:

The market discounts everything

Prices move in trends

History tends to repeat itself

Stock prices move in trends that persist for long periods. These trends canbe detected in charts. Thus past trends in market movements can be usedto forecast or understand the future. The lag between the time, atechnical analyst perceives a change in the value of a security and whenthe investing public ultimately assesses this change provides a profitopportunity to the chartist.

Dow Theory

Averages discount everything.

The market has three trends.

Major trend have three phases.

Volume must confirm the trend

This theory was first stated by Charles Dow.

Primary Trend Called the tide by Dow, this is the trend that defines thelong-term direction (up to several years).Secondary Trend Called the

waves by Dow, this is shorter-term departures from the primary trend

(weeks to months)


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Eliot Wave Theory

Elliot stated that stock market moves in repetitive cycles. The Elliot Wave

Principle is based on a repeating 8-wave cycle, and each cycle is made up ofsimilar shorter-term cycles. These waves have a rhythmic pattern and these

patterns can be used to predict future prices of stocks and predict trends of the

market. These waves move with investor psychology i.e. waves show an upward

trend when crowd is positive and too much positivity leads to a downward trend

in the wave.


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Trends

The meaning of trend in finance isn't all that different from the general definition

of the term - a trend is really nothing more than the general direction. A trend

represents a consistent change in prices (i.e. a change in investorsexpectations) A trend line is a simple charting technique that adds a line to a

chart to represent the trend in the market or a stock.

Types of Trends

1. Uptrend

2. Downtrend

3. Sideways Trend


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Support and Resistance

Support level is a price level where the price tends to find support as it is going

down

Resistance level is a price level where the price tends to find resistance as it is

going up

Importance of Support and Resistance Support and resistance analysis is an

important part of trends because it can be used to make trading decisions and

identify when a trend is reversing

Support and Resistance levels Support and Resistance levels are highly volatileTraders should not buy and sell directly at these points as there may bebreakout also.


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Breakout

The penetration of support and resistance level is called breakout

Traders Remorse

Returning to the level of support or resistance after a breakout is called traders

remorse.


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Volume Indicators

A mathematical tool that can be applied on securitys price giving a result that

can be used to anticipate trends, volatility and price Indicators are used in twomain ways: to confirm price movement and to form buy and sell signals.

Moving Averages

A simple moving average is calculated by taking average of most recent closing

prices of n time period. Sometimes traders use two moving averages to

determine buy and sell decisions. Using a slow moving average (more days)

together with a fast moving average (fewer days) generates the following

trading strategies:

Buy when the faster moving average crosses the slower one (from below). Sellwhen the faster moving average crosses the slower one (from above).

Buy when prices are above both the fast and slow moving averages. Sell when

prices are below both the fast and slow moving averages.

As with most tools of technical analysis, moving averages should not be used on

their own, but in conjunction with other tools that complement them. Using

moving averages to confirm other indicators and analysis can greatly enhance

technical analysis.

Relative Strength Index (RSI)

It compares the magnitude of recent gains to recent losses in an attempt to

determine overbought and oversold conditions of an asset

RSI= 100- 100/ (1+RS)

RS=EMA [U]/EMA [D] EMA- exponential moving average

U= Sig (close (today)-close (yesterday))

D= Sig (close (yesterday)-close (today))


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Balanced Application of both analysis necessary

No one method can give you the holy grail of profits. But what good traders and

investors can do is combine methods to provide a clearer picture of what ishappening and how to take advantage of opportunities in the share market.

No matter how you slice and dice the numbers, investing and trading is all about

choosing companies that are likely to increase in value for two main reasons:

1. The underlying business show potential and

2. Market forces are acting in its favor.

In the short run, strong fundamentals do not always indicate strong technical

patterns or vice versa. Often, technicals can continue to follow a strong or weak

pattern when fundamentals are at turning points, which may lead them to be out

of sync. Additionally, technical can be out of sync with fundamentals when there

is a shock to a stock, either positive or negative. Stocks tend to follow technicals

in the short run unless there is an unforeseen shock. Technical analysts say you

can respond real time to a stock and not have to wait for the next reporting date

or news disclosure, because the charts already interpret market sentiment, so

following the charts will lead to higher profits. Technical analysts believe that

stocks move even without disclosures because suppliers, competitors and

employees, invest in companies and without needing inside information, get a

sense of how the company is faring. These buying and selling activities define

the stock chart and pattern, and reflect the real-time stock behavior.

Therefore, even if the two have been out of sync in the short run, technicals and

fundamentals should be in sync in the long run. That's because in the long run,

fundamentals should win and drive the technical.


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Case Study: Failure of Analysis in the light of StockManipulation

Ketan Parekh Scam

A Mumbai based stock broker chartered accountant by profession

KP took advantage of low liquidity in certain stocks which later came to beknown as K- 10 Stocks

Held significant stakes in the K- The buoyant stock10 companies

markets from January to July 1999 helped the K-10 stocks increase invalue substantially

As a result other brokers and fund managers started investing heavily in

these stocks

The K-10 Stocks

1. Aftek Infosys

2. Himachal Futuristic Communications

3. Global telesystems

4. DSQ software

5. Silverline Technology

6. Satyam computers

7. Pentamedia Graphics

8.

Pritish Nandy Communications

9. Zee Telefilms

10.SSI

How it happened?

Formed a network of brokers

Identified and targeted 10 stocks K-10 stock, KP Index Zee telefilms went up from Rs. 127to Rs. 2330, Himachal Futuristic Rs.

194 to 2553

Badla System

Indigenous carry-forward system invented on the Bombay StockExchange

Badla trading involved buying stocks with borrowed money.

The stock exchange acts as an intermediary Interest rate determined bythe demand for the underlying stock

Maturity not greater than 70 days


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How it happened?

When stock prices were high, they were pledged with banks as collateral

No problems as long prices were rising

Pay order fraud

Issued cheques to MMCB drawn on BOI Went to BOI, SBI, and PNB and got pay orders discounted

How was it detected?

Stock market crash of 2000

KP started borrowing heavily

Attempted to rig the price upwards and later sell But failed to do so due to the pressure exerted by International bear

cartel

IT department found discrepancies in sources of funds of KP

Routine market surveillance of 5 stocks Systematic Flaws Trading system lag of one week Credit Check

High exposure allowed

Lack of records and margins at Calcutta stock exchange

Lending without proper collateral

Implications

One of the biggest Fall in BSE -700 points

KP and other traders were banned from trading for 17 years Short selling was banned for 6 months.

Badla system was banned

All shares that were put as collaterals should be done so through NSE andBSE.

Options and Index Future derivatives was introduced

10% additional deposit margins


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References

www.wikipedia.org/

www.investopedia.com/

http://www.slideshare.net/

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