L.L.T. Chap-2 :- Basic Elements Required For Performing Fundamental Analysis and Technical Analysis

As discussed in Chapter 1 of LETS LEARN TRADING (L.L.T) fundamental analysis is for long term investing purposes. While technical analysis for short term gains and constant change in positions. Both of these approaches have different elements for analysis. 

FUNDAMENTAL ANALYSIS

Fundamental analysis being a long term approach involves proper calculation of risk and return. The risk should be less as there is a large amount invested in one place. Also the future plans and complete information about the changes in the political situation as well as the sectoral situation should be taken care of.

Elements for fundamental analysis

  • Financial statements
  • Financial ratios
  • Market capitalization
  • Company’s debt and interest payments
  • Company’s performance and sectoral performance
  • Tracking the NEWS which could affect the company in long run
  • Industrial analysis
  • Future of Sectors in which company is working
  • Long term investment and holding capacity

Financial Statements and Ratios

Financial statements display what is the position of the company in terms of debt, loans, profits, operations, employees, future projects and cash flows. The statement defines the company’s current situation and its upcoming appetite for expansion. One of the important statements to look at while going through this process is the Cash flow statement. It displayed the liquidity of the company and all the income sources. Also by matching the cash flow of one year to another one can identify the increase or decrease in flow of money from a particular source.

Financial Ratios are the measuring tool for a company’s various activities. It not only helps in identifying the rate of progress for the company but also makes it easy to know about the internal changes made to speed up the procedure of work. There are numerous ratios that a company encounters. The important ones are Debt to equity ratio, P/E ratio, return on equity ratio, asset turnover ratio and operating profit margin ratio. There are others such as dividend ratio, P/E growth ratio and more. These ratios help to know the segment wise position of a company. For example the operating  profit margin ratio of two years helps the investor to know about the profit margins the company operates into. It displays the company’s ability to make profit from every rupee invested and every sale undertaken.

Market Capitalization

Market cap is the amount of money invested into the company from the general public. More the market cap and more investors the company has. The capitalization increases when the company diversifies its business or undertaking expansion. This means that whenever the size of the company increases the market capitalization of the firm increases. The investments in the company or the group cumulatively add up to get the market capitalization  of the company, In recent times the Adani Group Joined the Reliance group and Tata Group to become 100 Billion Dollar Corporate Groups in India.

Higher the market cap lessens the company’s chances of failure of blockage in expansion. The reason is bigger the size more the support from the nation’s govt. and the people. It is also said sometimes the market cap makes many companies eligible for achieving the “TOO BIG TO FAIL” milestone.

Company’s Debt and Interest Payments

This feature enables the investors to know about the current situation of the company on borrowings, Lesser the borrowings and external debt, lesser the interest payments. Hence outflow of cash goes down and savings increases within the company. Recently Reliance declared itself as a zero debt company. 

Company and Sectoral Performance

The company’s past performance from a historical database is the appendix before investing. One should look at the future of the sector the company is working into and the nation’s political influence over it. Forever the company’s individual product line and performance needs to be examined. The best way to opt for a company is to select a sector and plucking out the best from the pool. This means investing into the sector should be the primary motive and not the company.

After selecting a company one should carefully examine the sectoral performance. One best way to do it is – Keep a track of Industry P/E and Company’s individual P/E. This will give a better picture and vague idea about the company’s performance in comparison to the industrial performance.

NEWS 

Among various factors this is the most important one. The investors should keep a close look on the upcoming news and the trend of the market. There is one best example of it that could simplify it. 

Pathology Labs and COVID. Recently from last one year the COVID cases are on surge in India. This means that the Pathology labs would have an increased business due to RT/PCR testing. The beneficiaries are Dr Lal Path LAbs and many more. There are also Oxygen companies like Linda Industries who have grown multibaggers within one year due to the high rise in Business operations. Hence anticipating the sectoral news and selecting the stocks is the best usage of this element.

TECHNICAL ANALYSIS

The technical aspect keeps a view on the volatility and the traded volume. The reason is the short term tenure for trading involved. He traders here change the positions very quickly which result in high volume of tardes performed. Hence in the short term, price fluctuations get the terriers quick cash or quick loss. Thus the factors to determine the share pattern and price action are :

  • Supply and demand
  • Volume
  • Price action
  • Volatility
  • Charts
  • Indicators
  • Open interest
  • Resistance and support levels
  • Usage of stop loss and buying points
  • Charts and their time frames
  • Statistical tools
  • Holding capacity and risk levels for margin
  • Algo Trading
  • Stock specific News (for any stock or sector)

Stock Specific News

Back in Nov – Dec 2020, RBI’s committee passed a suggestion to give big finance companies and corporate houses (based on some criteria) to get banking  licenses in India. This resulted into skyrocketing of BAJAJ FINANCE and CHOLAMANDALAM FINANCE. These companies are NBFCs and have great market exposure. They also qualified as per the criteria laid by the committee. Just by a mere suggestion the prices of the companies skyrocketed within 2 months. Today with this positive comment and the profit figures BAJAJ FINANCE increased 20% in the last 1 week. 

Another example is for Dr. Reddys Labs. The vaccine partnership news of Dr. Reddy Took it too high of 5500 in the initial phase but later on the share price tumbled due to negative results and multiple lawsuits against it. The share price went down to 4200 – 4300 Rs. After that when the vaccine was finally at the edge of approval the share price rocketed to 5300 Rs. This was just a 3 weeks time period. The reason to keep a watch on such stocks is that there will be news flowing around the market and one should focus on which news and stay invested in one company for best returns in the long run.

Supply And Demand 

Demand and supply are the two sides of the same coin. As per the law of Economics more the demand – more the price of goods as the supply is always limited and vice versa. The same logic applies to any share. Whenever a positive news hits the market like a positive result or negative lawsuit of a company then the stock price does not change based on the news. Rather the price changes based on the demand and supply of the company’s stock. It is always up to the people who hold the equity to either drive the share price or lift it to new highs. 

The simple example is the announcement of quarterly results. Recently the Results of TCS were out and it made significant profit but yet the share prices dipped 4.5% on the next day. The reason is not the company’s bad performance or bad news. The reason is the demand and supply. People who had early access to inflation or had done proper analysis would have made investments in the company a long time back. Hence at the time of the result announcement they made a position and square it up when gain was achieved. This indicates one important feature of the stock market. Never ever look at the single day rise of a company not look at the pattern of rise for week or month. This will make it clear what the demand and supply force of the company really is.

Statistical Tools – Indicators and Charts – Volume and Volatility

Through the usage of Indicators and charts one can track the timely movement of the stock price. This helps to identify the support and resistance levels of the stock. The support level is the stock’s price which acts like a support when there is a panic sell and price erosion. Resistance level is the upper limit which once breached takes stock to new highs. These levels have numerous contracts attached to them. This means when such levels are broken there is a high number of buy and sell and hence the volatile price of that stock above or below that price is high. Hence Charts with different time frames helps to identify the trend and levels. 

The indicators help in deciding the appropriate entry and exit points, there are many indicators like Moving average, IChimoku Cloud and more. Their details are available here. These indicators assist in assuming the stock and market direction. They improve the probability of better returns.

ALGO TRADING

Algorithmic trading (Automated trading) is a legal trading practise in India since 2008. Today more than ⅓ of the stock market is involved in algorithmic trading techniques. Algorithmic trading in simple words is automatic trading by computers based on the preset parameters.

They include historical events, stock specific price movements, volatility, volume of stock trading, current market situation, risk appetite (margin), indicators and pattern identification, resistance and support levels, etc. Hence by coding all your specific requirements you can ask the computer or software to trade on your behalf if the price set by combination of your strategy gets hits.

Also there can be several test runs for knowing the efficiency of a strategy. Such a test run is known as Back-testing where you run your strategy against historical data and study the outcomes. For more information on ALGO TRADING CLICK HERE.

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