When choosing stocks for trading it is important to analyze those stocks as we are investing our hard-earned money in it. Stocks can be analyzed mainly by two methods- Fundamental analysis and Technical analysis.
Fundamental analysis is a method that helps in finding the intrinsic value of the stocks. By finding the intrinsic value of the stock one can get to know if the price of the stocks is cheap or expensive.
Technical analysis helps in forecasting the further price movements using charts like the line, bar, and candlestick charts. Technical analysis provides us with technical tools like indicators and patterns that help us predict further price movements.
Let us discuss in detail how we use both these methods to choose the right stocks for trading:
1. Fundamental Analysis:
As discussed above fundamental analysis is used to find out whether the stock is cheap or expensive. This can be done by finding out the intrinsic or fair value of the stock. To find the intrinsic value of the stock one needs to do the qualitative as well as the quantitative analysis of the companies.
The quantitative analysis mainly means analyzing the financial reports of the company to find the intrinsic value. It is important to check how the company has performed in the past years before we invest in that company.
To check the performance of the companies we have to analyze the financial statements like the balance sheet and profit and loss accounts which are present in the company’s annual and also quarterly reports.
This can be done by analyzing the ratios like the growth ratio, debt-equity ratio, etc.
These important financial ratios help us in understanding if the company is in debt or not or if the growth rate of the company is improving or not.
The next step is to do the qualitative analysis of the companies:
When we analyze the management of the company, it is known as the qualitative analysis. Management plays a key role in running the company.
Below are some qualitative parameters that an investor should look:
- The promoter’s shareholding
- The salary of the management,
- The managers’ background check
- Their efficiency in running the company.
- Peer Industries
- Competitive advantage
After doing both quantitative as well as qualitative analysis the investors can make good investing decisions like whether to invest their hard-earned money or not.
You may also like to read Fundamental Analysis vs. Technical Analysis Difference
Now, let us come to Technical Analysis:
2. Technical Analysis:
Technical analysis is mainly used to find the right entry and exit points of the stock. To find at which point to take a buy position in the stock or to square of our position we use Technical analysis.
Technical analysis consists of technical tools like chart patterns and indicators that help us in determining the entry and exit points.
1. Chart Patterns:
When we use candlestick charts, there are certain pattern formation on charts that help us in determining if the ongoing trend is going to continue or reverse. These patterns can be categorized as Bullish reversal patters, Bearish reversal patterns, Bullish continuation patterns and Bearish continuation patterns.
These patterns can be further categorized into single and multiple candlestick patterns. One needs to analyze these chart patterns to take important trading decisions like whether to buy or sell the stocks.
Technical indicators help in confirming the above pattern formations on the charts. These are mathematically calculated tools that help us in predicting further price movements and also helps in determining if the current trend is going to reverse or not.
These technical trading indicators also help us to determine if the prices of the stock are in the overbought or oversold zone. If the price is in the overbought zone then one should avoid buying as the uptrend is going to reverse to downtrend.
On the other hand, if the stock is in the oversold zone then one should avoid selling as the downtrend is going to reverse to the uptrend. Technical indicators can be categorized as trend indicators, momentum indicators, volatility indicators, and volume indicators.
Trend indicators are used to determine if the ongoing trend is uptrend or downtrend and if the trend is going to reverse or not. The other types of indicators are used to determine the momentum, volatility, and volume in the prices of the stocks.
Fundamental analysis is basically the background check of the companies as if you should invest or not in those companies. The technical analysis mainly involves finding the right entry and exit points. Some traders use both these methods to choose stocks. Whereas other traders use either fundamental or technical analysis for choosing stocks in which they want to invest.