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Part 1 Part 1 of 2: Using Fundamental Analysis

1 Use the value-investing concept to make decisions about stocks. The goal of value investing is to purchase stocks at a lower price than their true value. The value investor expects to be rewarded with an increased stock price as the firm’s fundamentals improve.
- Fundamental analysis considers the financial performance of a company. The goal of this analysis is to find a company’s intrinsic value.
- Intrinsic value is a company’s true value, based on the firm’s ability to generate profit and cash flow.
- For example, Acme Company has been a publicly traded stock for 20 years. During that time, they increased sales at an average rate of 15% per year.
- Because of growing sales and smart decisions about expenses, the firm’s profit has increased at an average rate of 5% per year.
- Therefore, Acme’s performance provides value to investors in two ways.
- First, the growth in profits allows Acme to pay an increasing dividend amount to shareholders.
- Second, Acme can keep some of the profits and use those dollars to grow the business.
- The fundamental investor believes that the financial results will eventually be reflected in the price of the stock.
2 Analyze a company’s discounted cash flows. Fundamental analysis states that a company’s true value is the sum of its discounted cash flows. Investor perceptions of a business impact the stock’s price. However, the fundamental analysis asserts that a stock’s value should be based on these cash flows.
- Once the company collects cash from its sales and pays its bills, any remaining cash represents profit.
- The cash flows are discounted into today’s dollars using the time value of money.
- The time value of money assumes that cash flows received in future years will be worth less, due to inflation.
- Consider the Acme example, assuming the firm’s profits increase at an average rate of 5% per year for the next 10 years.
- Also assume that the inflation rate will be 3% per year for 10 years.
- To compute the present value of the cash flows, first compute the total dollar amount of profit earned each year, using the 5% growth rate.
- Next, discount those future profits into today’s dollars using the 3% inflation rate.
3 Apply the discounted cash flow method to analyze a stock’s price. The future cash flows generated by company profits are all discounted using the time value of money. The sum of those cash flows is the true value of the stock.
- The Formula: true value of the stock divided by the number of common stock shares held by investors equals the true value per share.
- Why It Works: Calculating a value per share allows the investor to compare the stock’s true value to the current market price.
- How to Interpret Price vs. Value: If investors push the market price of the stock below the true value, fundamental analysis states that the stock is undervalued.
- Investors should buy the undervalued stock.
- For Example: The future value of Acme company’s earnings is $3,000,000 and Acme has 300,000 common stock shares held by investors.
- The true value per share is ($3,000,000 earnings) / (300,000 shares) = $10 per share.
- If the market price of the stock is below $10 per share, fundamental analysis states that the stock’s price is undervalued.
- On the other hand, a market price above $10 per share indicates that the stock is overpriced.

Part 2 Part 2 of 2: Applying Technical Analysis

1 Go over the technical analysis method. Technical analysis does not consider the financial performance of a company. The profits and cash flow of the business are not considered in this analysis.
- Technical analysis considers statistics related to the market activity of the stock–buys and sells.
- This analysis uses the stock’s historical change in price and the stock’s trading volume.
- Trading volume refers to the number of shares of a stock that are traded each day.
- A technical analyst believes that historic trends in a stock’s price can be used to predict a future change in the stock’s price.
- Technical analysts also believe that changes in trading volume can be used to predict a change in a stock’s price.
2 Use a stock’s moving average in price to determine a market trend. Moving average simply adds up the price of a stock for a certain period and divides that total by the number of trading days in the period. Moving average is a statistic used to chart a trend in a particular stock’s price.
- If the moving average increases at a faster rate, that change indicates that a technical investor should buy the stock.
- If the moving average decreases at a faster rate, a technical investor may sell the stock.
- The trend is considered broken when the stock price reverses the moving average line.
- For example, you add up the prices of IBM stock for the first 10 trading days of October, then divide the total by 10. The average price is $150.
- You then repeat the calculation each trading day (weekdays when the stock market is open).
- On October 11th, you calculate the moving average for the prior 10 trading days, including the 11th.
- Drop the first day and add the 11th day to maintain a ten day average.
- Each day’s moving average calculation will be slightly different.
- If your analysis shows moving average prices of $150, $150.75 and $152, you can conclude that, over time, the trend of the stock price is slowly increasing.
3 Research the price of a stock using trading volume. Trading volume refers to the number of shares that trade during a specific period of time (Day, week, month). Trading volume results are usually combined with other types of analysis to make a decision about buying or selling a stock. Most technicians consider price movement without volume as having little value.
- Assume that IBM’s common stock normally trades 100,000 shares per day.
- If the number of shares traded increased or decreased sharply, that may be an indication of a trend.
- Say, for example, the trading volume increased to 150,000 shares per day and the stock’s moving average began to increase sharply.
- The increases in both of these technical indicators may present a signal to buy the stock.
- Increasing volume with an upward trend indicates accumulation, while increasing volume with a downward trend means liquidation.
- If the trading volume increased and the moving average declined sharply, that may indicate a downward trend for the stock.
- The technical analyst may conclude that more people are selling the stock, due to the increase in trading volume and the price decline.
4 Technical analysts also consider short interest as well as support and resistance levels. These additional considerations help them to determine buying or selling opportunities.
- Short interest measures the total number of shares of a stock that have been sold short without being covered or closed out.
- A high short interest is a red flag.
- Support and resistance levels refer to price levels beyond which the price of an asset will not go in a certain direction.

How to Analyze Market Trends

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