Fundamental and Technical Analysis

Fundamental Analysis is an approach to forecast the movement of share price of a particular company using financial and economic analysis. Technical Analysis is another approach to forecast the share price by examining past price movement.

We will study this chapter into two parts:

1. Fundamental Analysis

Fundamental Analysis is an approach to forecast the movement of share price of a particular company using financial and economic analysis. It includes analysis of financial and non-financial information such as company’s balance sheet, profit and loss account, cash flow statement, demand for the products, competitors, growth, changes in government policies and so on. It is applied mainly for period of more than 6 months and above.
Forecasted share price is also known as ‘intrinsic value’ or ‘target price’.

If intrinsic value of a stock >current market price -> Investor would purchase the stock as according to his estimates price will move towards its intrinsic value

If intrinsic value of a stock < current market price -> Investor would sell the stock as according to his estimates price will go down and come closer to its intrinsic value

There are two approaches to analyze the stock of a particular company:

Top-Down vs. Bottom-Up Investment Analysis

top down and bottom up investment analysis

Economic Analysis

Various factors are taken into consideration such as:

  • Fiscal & monetary policy
  • Employment statistics
  • Inflation figure
  • Interest rate
  • GDP growth rate

Industry Analysis

Various parameters are considered while performing industry analysis. Some of which are as follows:

  • Industry life cycle
  • Analysis of competitors
  • Demand & supply conditions
  • Legal/Regulatory compliances
  • Risks

Firm Analysis

While evaluating a particular firm, we need to determine and analysis the following things:
  • Discount rate and beta of the company
  • Financial statements
  • Ratio analysis
  • Risk factors
  • Management of the company
  • Discounted cash flow analysis
  • P/E Ratio

2.Technical Analysis

Technical Analysis is another approach to forecast the share price by examining past price movement. The techniques/charts and its interpretations remain the same for the equity market, derivative market or commodity market which is not in case of fundamental analysis.

It can applied for intraday (it may be 1 minute, 5 minutes, 15 minutes), daily, weekly and monthly.

We will focus and understand one of the most widely used chart in technical analysis i.e. candlestick chart.

I.Candlestick Chart and ITS Signals

It is a pictorial representation of the price action in a particular session (it may be for 1 minute, 1 hour, 1 week, 1 month or 1 year)

Body of Candlestick:

technical analysis candle stick chart

A typical candlestick has one body and two shadows, combining the two is known as range of the candlestick. The body shows the open and close prices. In bullish candles, the close price is higher than the open price and in bearish candle; the close price is lower than the open price.

In order to distinguish the bullish and bearish candles from each other, they are displayed with different colors. Usually bullish candles are white or green and bearish candles are black or red.

We will look and understand the various types of
1.Single Candlestick
2.Candlestick Pattern

Types of Single Candlestick

1) Marubozu

Marubozu is a candlestick having no upper or lower shadow. It has only candle body. It is divided into two:

a) Bullish Marubozu

In Bullish Marubozu open is equal to low and close is equal to high i.e. LOW=OPEN & CLOSE=HIGH. It signifies that investors are willing to buy the stock at any price such that its highest price is the closing price. Past trend does not matter; bullish Marubozu suggests that stock is now going to be bullish in nature.

Bullish Marubozu b) Bearish Marubozu

In Bearish Marubozu OPEN=HIGH & CLOSE=LOW. It signifies that investors are willing to SELL the stock at any price so much that stock closes at its low point. Past trend does not matter; bearish Marubozu suggests that stock is going to be bearish in nature.

Bearish Marubozu

Doji forms when the open and close prices are equal implies that they do not have any body and do not possess any color (neither bullish nor bearish)

Doji means that bulls (buyers) and bears (sellers) are well matched and none of them is stronger than the other one. It cannot be predicted whether price in future will go upwards or downwards as bulls are unable to increase the prices and bears are not able to decrease the price.

Therefore, Doji depicts indecision and uncertainty signal which requires confirmation. It implies that after a Doji the trend can continue, reverse or start moving sideways.

What to do when you see a Doji: If you hold a position, you would better to close it and collect your profit when Doji is formed and if you do not hold any positions, wait for the candlestick to form the trend.

Doji pattern 3. Hammer and Hanging Man

‘Hammer’ and ‘Hanging Man’ are two opposite candlesticks. They have large lower shadows and small sized bodies with no or very small upper shadow. Interestingly, color of candlestick does not matter (i.e. bullish or bearish) because in this trend matters.

We call it ‘Hammer’ when you find on a downtrend of the graph which is giving signals that downward trend is about to end. Similarly, we call it ‘Hanging Man’ when you find on an upward trend of the graph which shows that upward trend is going to end.

hammer candle stick hanging man candle stick

It is important to note that like Doji, ‘Hammer’ and ‘Hanging Man’ depicts indecision and uncertainty which requires confirmation. In case of ‘Hammer’ we need to wait for the bullish trend to form and after that go for long (buy) and in ‘Hanging Man’ we have to wait for bearish candle to form and after that go for short (sell).

4. The Spinning Top

The Spinning top has small body with lower and upper shadow being almost equal. The difference between open and close (body of the candlestick) in both bullish and bearish candlestick is very less.

the spinning top pattern

It is situation of indecision as both buyers and sellers are unable to influence the market. If spinning top is identified either in uptrend or downtrend, two possible trends can be identified post spinning top i.e. either:

  • market will continue that trend (downward/upward), or
  • reverse trend can been seen
5. Shooting Star

It is one of the most powerful and popular tool in candlestick charts. It has long upper shadow which is about twice the length of the body of the candlestick just opposite to ‘Hanging Man’. Color of the candle does not matter, what is more important is the previous trend.

The Shooting Star is a bearish pattern so it is MUST that prior to the shooting star the trend must be bullish and pattern will get reversed (downtrend) post shooting star.

shooting star pattern TYPES OF CANDLESTICK PATTERNS:

1) High-Wave

A group of candlesticks having small bodies and long shadows are known as High Wave which is a strong reversal signal (implies whatever the previous trend was, it might get reversed).

high wave candle stick

2) Engulfing Pattern

It is formed by two candles. It is of two types
  • Bearish Engulfing Pattern
  • Bullish Engulfing Pattern

In Bearish Engulfing Pattern, a small candle having bullish body is completely covered/absorbed by the body of the next candle having big bearish body on an upward trend depicts a strong reversal pattern where there is good chance to get short (sell).

Whereas in Bullish Engulfing Pattern, a small candle with bearish body is completely covered by the body of the next candle having big bullish body on a downtrend depicts a strong reversal pattern to go long (buy).

’engulfing pattern candle stick

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