Stock Analysis Explained

Written by Jacey Harmon
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There is no right or wrong way to analyze a stock. In truth, the type of analysis you will want to understand, and perform, depends on what type of investor you are. Day traders will want to learn how to utilize short term indicators. Value investors will want to have a solid understanding of fundamental analysis. For a beginning investor, learning how to understand and use stock analysis can make one feel overwhelmed.

The Basics of Stock Analysis Explained

There are basically two types of stock analysis: fundamental and technical analysis. Fundamental analysis is what is utilized to identify a specific company's financial health. Earnings and revenue growth, as well as cash flow and profit margins are a few of the financial aspects fundamental analysis analyzes. Corporate earnings growth, or at least potential growth, is the main driver behind a stock's price advance. Understanding how a company's earnings are growing is essential to stock analysis.

Technical analysis is that which analyzes the price and volume of a specific stock, or the general market as a whole. Price and volume will show the psychology of the market. When properly utilized, one can identify which stocks are in demand by institutions. Institutional investors are the driving force behind the market. When these deep pocketed investors decide to buy a stock, they can easily drive the price higher for an extended period.

Price and volume analysis is not the only technical analysis tool investors can utilize. Short term traders can utilize stochastics to anticipate short term swings in a stock's price. Stochastics are complicated computer models which measure whether the stock is currently "oversold" or "overbought." To compare the price strength between companies, investors can use "relative strength." Relative strength typically measures a stock's performance against the S&P 500. A high relative strength indicates a stock which is in demand, and vice versa.

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Fundamental analysis and technical analysis tips

Below is just a little information on this topic from my small unique book "The small stock trader":

The most significant non-company-specific factor affecting stock price is the market sentiment, while the most significant company-specific factor is the earning power of the company. Perhaps it would be safe to say that technical analysis is more related to psychology/emotions, while fundamental analysis is more related to reason – that is why it is said that fundamental analysis tells you what to trade and technical analysis tells you when to trade. Thus, many stock traders use technical analysis as a timing tool for their entry and exit points. Technical analysis is more suitable for short-term trading and works best with large caps, for stock prices of large caps are more correlated with the general market, while small caps are more affected by company-specific news and speculation…:

Fundamental analysis

Perhaps small stock traders should not waste a lot of time on fundamental analysis; avoid overanalyzing the financial position, market position, and management of the focus companies. It is difficult to make wise trading decisions based only on fundamental analysis (company-specific news accounts for only about 25 percent of stock price fluctuations). There are only a few important figures and ratios to look at, such as:

• EPS/Revenue
• Cash/EBIT(TA)
• Margins
• Debt
• Management
• Products
• Shareholders
perhaps also:
• P/E
• Dividend yield

Furthermore, single ratios and figures do not tell much, so it is wise to use a few ratios and figures in combination. You should look at their trends and also compare them with the company’s main competitors and the industry average. Preferably, you want to see trend improvements in these above-mentioned figures and ratios, or at least some stability when the times are tough.

Technical analysis

Despite all the exotic names found in technical analysis, simply put, it is the study of supply and demand for the stock, in order to predict and follow the trend. Many stock traders claim stock price just represents the current supply and demand for that stock and moves to the greater side of the forces of supply and demand.

If you focus on a few simple small caps, perhaps you should just use the basic principles of technical analysis, such as:

• Price and volume
• Support and resistance
• Trends and moving averages

I have no doubt that there are different ways to make money in the stock market. Some may succeed purely on the basis of technical analysis, some purely due to fundamental analysis, and others from a combination of these two like most of the great stock traders have done (Jesse Livermore, Bernard Baruch, Gerald Loeb, Nicolas Darvas, William O’Neil, and Steven Cohen). It is just a matter of finding out what best fits your personality.
I hope the above little information from my small unique book was a little helpful!

Mika (author of "The small stock trader")