Fundamentals analysis says the best way to predict the future trends of a stock is to understand the financial figures of the underlying company. The fundamental analyst would calculate a theoretical value of the company using cash flow analysis, recent dividends and earnings, future dividends and earnings projections plus a host of other economic numbers. If the current stock price is lower than the calculated value, a trader who uses fundamental analysis would buy this stock.
This writer has the opinion that fundamental analysis is difficult to master for it to be useful as a forecasting tool. Understanding and analyzing balance sheets and profit and loss accounts is not enough. You will need to analyze the micro and macroeconomic picture as well. Often you will need to be have the same knowledge equivalent to senior-management of a company you want to analyze – minus the leadership and management skills.
Take the example of Google’s free 2 GB e-mail service. How much does it cost them? Probably about $2 yearly for each customer. Assuming 100 million internet users sign up, the advertising revenues from this segment alone would provide a tidy profit. It is the analyst job to provide a good educated-guess of this number. More importantly, this new signings will provide a customer base to challenge Yahoo and Microsoft. With Google’s dominance in the search engine market, the data mining of such a huge pool of internet users will provide them with an edge in deciding future strategies over its two nearest rivals. Try translating this to what can Google earn in the next two quarters.
One of the better tools is the Z-Score, developed by Edward Altman, a financial economist and professor at New York University’s Stern School of Business, in 1968 to predict corporate bankruptcies within a two-year period. This formula has a 70-plus percent accuracy rate
The “price action discounts everything” premise is central to charting, also known as technical analysis. Technical analysis uses graphic representations for prices and makes uses of various quantitative techniques to forecast price trends.
A technician makes profits in any market by having positions in line with the price trend. When the trend is up, then buy. Conversely, when the trend is down, then look to sell. Technical analysis is not an exact science, but it is easy to learn and effective.
Technical analysis is a good starting point for beginners. The foundation should include classical technical analysis, Japanese candlesticks, trendlines, RSI, MACD, ADX, stochastics and moving averages. Learners can complete these core topics within three to six months. With constant practice, you should be able to independently analyze and identify the current trends in the stock market.
Most users of stock charts may only focus on daily charts. However, if users pay equal attention to weekly as well as monthly charts, the picture is intuitively more complete. This is equivalent to understanding how the short, medium and long-term investors are viewing the markets, after all three main types of investors form the market. A handful of stock charting software has this feature of showing say, the relative strength index for the daily, weekly and monthly values on a single screen.
One last point – no single method in technical analysis is sufficient for real-world investing. For example, even if you master Elliott Wave Theory or Gann techniques, by itself it would bring more heartache and disappointment. Often, you will need knowledge from other disciplines and sources to improve your overall investing skills.
Some tips for successful investing in stock markets.
1. Investing is a business. The rules of running a profitable business are the same as investing in stock markets.
2. Learn to spot your own mistakes fast. When a mistake is made, exit your position and live to fight any day. The faster you realize your own mistake and the faster you react will reduce your losses, hence increasing your chances of winning in the long run. A useful method is using a 10% stop loss exit strategy. If you are long, and your stock price goes down by 10%, exit. If this same stock reverses and starts to surge, take this as your mistake of not identifying a more accurate (lower) entry point.
3. Understand yourself inside out. What makes you happy, sad, excited, depressed, ecstatic – the whole spectrum of human emotions are merely states of the mind. This is easier said than done but you have to keep improving your own control mechanisms.
4. Learn the methods of successful fund managers – diversification, emotional detachment and having realistic expectations. Investing is a marathon not a sprint.
5. Money management skills. Whether the amount is $10,000 or $10 billion, the same rules apply. There are plenty of sources of information on this subject from the internet.
6. Learn technical analysis.
The main thrust of this article is to avoid making mistakes that will cost you dearly. How you prepare yourself for bear markets, sideways markets and market crashes are vital to your success.
There are no secrets in investing – no magic formula, no discovery of some useful ancient secrets. Just knowledge, hard work, common sense and discipline will serve you well in the years ahead. This verse from a 2500-years-old text is a useful reminder:
“Those who know do not speak,
Those who speak do not know.”
– Tao Te Ching, 56th verse
Stan Seecrets’ Postulate: “There are two types of people in the world – those who know what they don’t know and those who don’t know what they don’t know.”
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