Investment Management

Unit – V

Fundamental Analysis
and
Technical Analysis
Fundamental Analysis
Fundamental Analysis
 Economic analysis
Economic indicators
1) Gross Domestic Product
2) Savings & Investments
3) Inflation
4) Interest rates
5) Budget & Fiscal deficit
6) Tax structure
7) BOP
8) FDI
9) FII
10) International Economic conditions
11) Business Cycles & Investor psychology
12) Monsoon & Agriculture
13) Infrastructural facilities
14) Demographic factors
Industry analysis
Kinds of Industries

• Growth Industry
• Cyclical industry
• Defensive industry
• Cyclical growth industry
 Factors to be considered in Industry
analysis
1) Growth of the industry
2) Cost structures and profitability
3) Nature of the product
4) Nature of competition
5) Government policy
6) Labor productivity
7) Research and development
 Company Analysis
• Evaluating the financial performance of a
company on the basis of the qualitative
and quantitative factors is called company
analysis
Qualitative factors
• Business model
• Management
• Corporate Governance
• Corporate culture
Quantitative factors:
• Earnings
• Financial leverage
• Operational Leverage
• Production Efficiency
• Financial Analysis
 Which is better?
• Compare significant ratios and statistics.
• Read current news and annual reports to
see what their plans are in the future.
• Look for historical growth and continued
opportunity for growth.
Technical Analysis
 Technical Analysis Introduction

• Two major types of analysis for predicting the

performance of a company’s stock
– fundamental
– technical
• Technical
– looks for peaks, bottoms, trends, patterns, and other
factors affecting a stock’s price movement
– makes a buy/sell decision based on those factors
Technical Analysis Introduction
(Continued)
• The world of technical
analysis is huge
• Hundreds of different
patterns and
indicators
• investors claim to be
successful
 What is Technical Analysis?
• Method of evaluating securities by
analyzing statistics generated by
– Market activity
– Past Prices
– Volume
• Do not attempt to measure intrinsic value
• Instead look for patterns and indicators on
charts to determine future performance
 What is Technical Analysis?
(Continued)
• Technicians believe
that securities move
in very predictable
trends and patterns
• Trends continue until
something happens to
change the trend
• Until that change
takes place, price
levels are predictable
 What is Technical Analysis?
(Continued)
• Most agree that
technical analysis is
much more effective
when combined with
fundamental analysis
 Basic assumptions of technical analysis

1) Market value is determined solely by the

interaction of supply and demand for
securities
2) Supply and demand factors are determined
by both rational and irrational factors
3) Changes in trends are caused by shifts in
supply and demand
4) Stock prices tend to move in trends which
persists for an appreciable length of time.
Arguments in favor of technical
analysis ( against fundamental
analysis)
1)Fundamental analysis involves compilation and
analysis of huge amount of data. So, complex
and time consuming
2)Fundamental factors may undergo change before
the prices of underpriced securities go up.
3)Financial statements being basic inputs for
fundamental analysis are affected by subjectivity,
inadequate disclosures, etc. which affect the
quality of fundamental analysis.
 Dow Theory
• This theory was first stated by Charles
Dow in a series of columns in the WSJ
between 1900 and 1902.
• Dow (and later Hamilton and Rhea)
believed that market trends forecast trends
in the economy.
 Dow Theory Trends (1)
• Primary Trend
– Called “the tide” by Dow, this is the trend that
defines the long-term direction (up to several
years). Others have called this a “secular”
bull or bear market.
• Secondary Trend
– Called “the waves” by Dow, this is shorter-
term departures from the primary trend
(weeks to months)
• Day to day / minor fluctuations
– Not significant in Dow Theory
Dow Theory Trends (2)
 Does Dow Theory Work?
• According to Martin Pring, if you had
invested $44 in 1897 and followed all buy
and sell signals, by 1981 you would have
accumulated about $18,000.
• If you had simply invested $44 and held
that portfolio, by 1981 you would have
accumulated about $960.
 Type of charts
1)Bar charts
2) Point and figure charts
3) Line charts
4) Candlesticks
 The Bar Chart

Bar charts are one of the most popular types of charts used in
technical analysis.
The top of the vertical line indicates the highest price a security
was able to trade during the day, and the bottom represents
the lowest price.
The closing price is displayed on the right side of the bar and
opening prices are shown on the left side of the bar.
This bar represents a day of trading.
 The Point & Figure Chart
This type of chart is somewhat rare and most charting services do not offer the point
and figure chart.
This is a chart that plots day-to-day price increases and declines.
A rising stack of X’s represents increases while a declining stack of O’s represents
decreases.
These types of charts were traditionally used for intraday charting (a stock chart for
just one day), mainly because it can be long and tedious to create P&F charts over
a longer period of time manually.
The idea behind P&F charts is that they help to filter out less-significant price
movements and let you focus more on the most important trends.
There are two attributes that affect the appearance of a Point & Figure chart, box
size and reversal amount
Box size In the context of Point & Figure Charts, the box size is the minimum price
change that must occur for a given period before a mark (an X or an O) is added to
the chart.
Reversal amount In the context of Point & Figure Charts, the reversal amount is
the number of boxes (an X or an O) required to cause a reversal. Moving the next
column and changing direction would represent a reversal.
 Price Patterns
• Technicians look for many patterns in the
historical time series of prices.
• These patterns are reputed to provide
information regarding the size and timing
of subsequent price moves.
• But don’t forget that the EMH says these
patterns are illusions, and have no real
meaning. In fact, they can be seen in a
randomly generated price series.
Line chart
 Point and Figure Chart
• Somewhat rare
• Plots day-to-day increases and declines in price.
• A rising stack of XXXX’s represents increases
• A rising stack of OOOO’s represents decreases.
• Typically used for intraday charting
• If used for multi-day study, only closing prices
will be used
Point and Figure Chart
 Point and Figure Chart
(continued)
• Helps to filter out less-significant price
movements allowing analyst to focus on most
important trends
• Used to keep track of emerging price patterns
– No time dimension
• Two attributes affecting the appearance of a
point & figure chart
– Box size
– Reversal amount
 Head and Shoulders
H&S Top
• This formation is Head
characterized by two
small peaks on either Left Shoulder Right Shoulder

side of a larger peak.

• This is a reversal
Neckline

pattern, meaning that H&S Bottom

it signifies a change in Neckline

the trend.
Left Shoulder Right Shoulder

Head
Head & Shoulders Example

Sell Signal

Minimum Target Price

Based on measurement rule
 Triangles
• Triangles are
continuation
formations. Ascending

• Three flavors:
– Ascending Symmetrical
– Descending
Symmetrical
– Symmetrical
• Typically, triangles
should break out Descending
about half to three-
quarters of the way
through the formation.
 Rounded Tops & Bottoms
• Rounding formations Rounding
are characterized by Bottom
a slow reversal of
trend.

Rounding Top
 Academic perspectives of technical analysis

Academic researches and Studies are

conducted on ---
1. “ what works better – Fundamental or
Technical analysis”.
2. Statistical and mathematical techniques
are the base of technical analysis
3. Methods are developed to measure the
effectiveness of a trend prediction and
forecasting techniques
 Relative Strength Analysis (RSA)
In markets, some securities possess greater relative strength and hence
outperform the market.
It is based on the assumption that prices of some stocks rise rapidly during
the bull phase but fall slowly during the bear phase in relation to market as a
whole.
Technical analysis is used to judge whether a stock or a industry has relative
strength.
Let PA be security prices, PIA be industry prices and PM be market index
values.
Then, PA / PIA – Indicate the relative strength of the security against the
industry.
PIA / PM indicate the relative strength of the industry against the market
and
PA / PM indicate the relative strength of the security against the market.
These ratios can be presented on the graph to ascertain the trend.
 Relative strength index (RSI)
It was developed by Wells Wilder. It determines the
technical strength or weakness of a particular scrip or
market.
It is calculated as follows –
RSI = 100 – (100/(1+Rs))
Where,
Rs = Average gain per day / Average loss per day
The broad rule is,
If the RSI crosses 70, there may be downturn and it is a
time to sell. If the RSI falls below 30, it is time to pick up
the stock.
 Japanese Candlesticks
• This is a Japanese Candlestick (open, high, low,
close).
• Chart of AMAT from early July to mid October
2001
Candle Stick Charting
 Simple Moving Averages
MSFT Daily Prices with 10-day MA
• A moving average is 9/23/93 to 9/21/94

60
simply the average price
(usually the closing 55

price) over the last N

periods. 50

• They are used to smooth

Price
45

out fluctuations of less

than N periods. 40

• This chart shows MSFT 35

with a 10-day moving

30
average. Note how the 1 21 41 61 81 101 121 141 161 181 201 221 241

moving average shows Date

much less volatility than

the daily stock price.
 MACD
• MACD was developed by Gerald Appel as a way
to keep track of a moving average crossover
system.
• Appel defined MACD as the difference between
a 12-day and 26-day moving average. A 9-day
moving average of this difference is used to
generate signals.
• When this signal line goes from negative to
positive, a buy signal is generated.
• When the signal line goes from positive to
negative, a sell signal is generated.
• MACD is best used in choppy (trendless)
markets, and is subject to whipsaws (in and out
rapidly with little or no profit).
MACD Example Chart
Distinction between Fundamental and Technical Analysis

S.No Point of difference Technical Analysis Fundamental Analysis

1 Focus Short term price movements Long term values

2 Input Internal market data – Price Economic , industry and

and Volumes. company factors

3 Appeals to whom? Short term traders, Genuine and Long term

Speculators investors

4 Approach Charting, moving average ) Top down / EIC Approach

ii) Bottom-up / CIE Approach
analysis, RSA, RSI,
Candlesticks, etci

5 Investment styles Active style Passive style

Thanks