Trend Analysis

This method of analysis studies the percentage relationship that each item of the financial
statement bears to the same item in the base year. Through this analysis the analyst seeks to
review changes that have taken place in individual categories therein from year to year and
over the years. Thus, trend analysis can take the form of year-to-year comparisons, index
number, trend series and trend ratio.

Under this method analysis trend in respect of certain financial items is studied by computing
the year-to-year change in absolute terms or in terms of percentages. In this method, the base
year changes every year. In order to calculate a series of index number a base year should be
chosen. ·This base year will, for all items have an index amount of 100. In choosing the base
year, the analyst should see that a normal year, in which abnormal events have not taken
place, is chosen. Index numbers of an item for different years are computed by reference to
the base year. If the value of the item in a year is less than that in the base year, the trend
percentage will be below 1oo per cent if the amount is more than the base amount, the trend
percentage will be above 100 per cent.

Technical analysis
As discL1ssed in the chapter or Fundamental Analysis there are two approaches to analyse a
company's stock viz. Fundamental an analysis and Technical analysis. Fundamental analysis
involves analysing various factors such which affect company's cash flows and its income in
order to estimate its value.

Technical analysis takes a completely different approach. it doesn't care one bit about the
"Intrinsic value" of a company. Technical analysts are only interested in the price
movements in the market.

Despite all the fancy jargons and technical It employs technical analysis really just studies
supply and demand in a market in an attempt to determine what direction, or trend, will
continue in the future and to gauge investor sentiments. In other words, technical analysis
attempts to understand the emotions in the market by studying the market itself, as opposed to
its components.

Fundamental analysis believes that market movement is 90% due to logical factor such as
economic situation and company’s performance and 10% due to emotions prevailing in stock
market as against this technical analysis believes reverse. i.e. market movement is 10% due to
logical factor and 90% due to investor emotions. If you understand the benefit and limitations
of technical analysis, it can give you a new set of tools or skills that will enable you to be a
better traders or investor.
THE BASIC ASSUBEPTIONS UNDER TECHNICAL ANALYSIS
Technical analysis is a method of evaluating securities by analysing the statistical data
generated by market activity, such as past prices and volume of trading of a particular share.
Technical analysis do not attempt to measure a security's intrinsic value, but instead use
charts and other tools to identify patterns that can suggest future activity.

Just as there are various tools available for fundamental analysis (for e.g. Ratio analysis,
studying internal management patter of the company, etc.), there are also many different type
of technical traders. Some rely on chat patterns others use technical indicators, and may also
use some combination of the two. But the fact that, technical analysis only uses historical
price and volume data separates them from their fundamental counterparts. In only thing that
matters to them is a security’s past trading data in terms of price & volume and what
information this data can provide about future movement of the share price.

The field of technical analysis is based on three assumptions: (1) the market discounts
everything. (2) Price move in trend (3) history tends to repeat itself.

The Market Discounts Everything

A major criticism of technical analysis is that it only considers price movement, ignoring the
fundamental factors of the company. However, technical analysis assumes that. At any given
time, a stock's price reflects everything that has or could affect at, the company-including
fundamental factors and therefore is not required to be considered separately. This only
leaves the analysis of movement, which any individual knows is a. product of the supply and
demand price for a particular stock in the market.

Price Moves in Trends

In technical analysis, price movements are believed to follow trends. This means that the
future price movement is most likely to be in the same directions the trend than to be against
it after the same has been established. Most strategies of technical analysis are based on this
assumption.

History Tends to Repeat Itself

Another important idea in technical analysis is that history tends to repeat itself, mainly in
terms of price movement. The repetitive nature of price movements is attributed to market
psychology, in other words, market participations tend to provide a consistent reaction to
similar market situation over time. Technical analysis uses chart patterns to analyse market
movements and understand trends. Although many of these charts have been used from
centuries, they are still believed to be relevant because they provide patterns of price
movements that are often repetitive.
CHARTING TECHNIQUES
There are four main types of charts that are used by investors and traders depending on the
information that they are seeking and their individual skill levels.

The chart types/Charting Techniques are :

a) The line chart,

b) The bar chart,

c) The candlestick chart and

d) The point and figure chart.

All the above techniques are discussed in details, notice how the data used to create the charts
is the same. But the way is data is plotted and shown in the charts is different.

a) Line Chart: - Line charts represent only the closing prices over a set period of time and
are there four the most simple of the four charts. Line charts do not provide visual
information of the trading range for the individual points such as high low and opening
prices. But The closing price is often considered to be the most vital price in stock data
compared to the high and low for the day and this is why it is the only value used in line
charts.

(b) Bar Chart: - The bar chart is an extension of line charts in a sense that it adds much
more key information to each data point. The chart is made up of a series of vertical lines that
represent each data point. This vertical line represents the high and low for the trading period,
along with the closing price. The close and open are represented on the vertical line by a
horizontal dash. The opening price on a bar chart is denoted by the dash that is located on the
left side of the vertical bar. As against this, the close is represented by the dash on the right.
Generally, if the left dash (open) is lower than the right dash (close) then the bar will be
shaded black, representing an upward movement of the stock, which means it has gained
value. When this is the case, the dash on the right (close) is lower than the dash on the left
(open).
c) Candle Stick Charts:- The candle stick chart is similar to a bar chart, but it is visually
constructed. Candlestick also has a thin vertical line showing the period's trading range which
is similar to the bar chart. But the difference lies in the formation of a wide bar on the vertical
line, which indicates the difference between the open and close. And, like bar charts
candlesticks also rely heavily on the use of colours to explain activities of share price during
the trading period. A major problem with the candle stick charts is the colour configuration,
therefore, it is Important to understand the candlestick configuration used at the chart. There
are two colour constructs for days up and one for days that the Price falls. When the price of
the stock is up and closes above the opening trade, the candlestick will usually be white or
clear. If the stock has traded down for the period, then the candlestick will usually be red or
black. if the stock's price has closed above the previous day's close but below the day open,
the candlestick will be black or filled with the colour that is use to indicate an up day. Refer
the following figure to understand the concept:

Note: an up day is signified by a white (or empty) box.

A down day is represented by a black or shaded box.

The "box" shows the open to close range.

The "wick" displays the full day's range.

d) The point and figure chart: - the point and figure chart is not well known or used by the
average investor but it has had a long history of use dating back to the first technical traders.
This type of chart reflects price movements and is not as concerned about time and volume in
the formulation of the points. The point and figure chart removes the noise, or insignificant
price movements, in the stock, which can distort trader’s views of the price trends. These
types of charts also try to neutralise the skewing effect that time has on chart analysis.

Point & Figure Chart

When first looking at a point and figure chart, you will notice a series of Xs and Os. The Xs
represent upward price trends and the Os represent downward price trends. There are also
numbers and letters in the chart; these represent months, and give investors an idea of the
date. Each box on the chart represents the price scale, which adjusts depending on the price of
the stock: the higher the stock's price the more each box represents. On most charts where the
price is between $ 20 and $ 100. a box represents. $1 or $1 point for the stock. The other
critical point of a point and figure chart is the reversal criteria. This is usually. Set at three but
it can also be set according to the chartist's discretion. The reversal criteria set how much the
price has to move away from the high or low in the price trend to create a new trend or, in
other words, how much the price has to move in order for a column of Xs to become a
column of Os, or vice versa. When the price trend has moved from one trend to another, it
shifts to the right, signalling a trend change.
CHART PATTERNS
A chart pattern is a distinct formation on a stock chart that creates & trending, or a signal or a
of future Price movements. Chartists use the, se pattern to identify current trends and trend
reversals and to trigger buy and sell signals.

The theory behind chart a pattern is based on the third assumption I. e. History repeats itself.
The idea is that certain patterns are seen many times, and that these patterns signal a certain
high possibility of movement in a stock. Based on the past trend of a chart pattern setting up a
certain price movement, chartists look for these patterns to identify trading opportunities.

While there are general ideas and components to every chart pattern, there is no chart pattern
that will tell you with absolute certainty the direction in which security is headed. This
creates some scope of debate as to what a good pattern looks like, and is a major reason why
charting is often seen as more of art than a science.

Reversal and continuation are two types of patterns within the area of technical analysis.
Reversal pattern signals that an earlier trend will reverse on completion of the pattern. A
continuation pattern, on the other hand, signals that a trend will continue once the pattern is
complete. These patterns can be found over charts of any timeframe.

Trends
Trend is one of the most important concepts in technical analysis. A trend is really nothing
more than the general direction in which a security or market is headed. Take a look at the
chart below, anyone can conclude that trend is up. However, it's not always this easy to see a
trend for example refer Figure there is lot of opposite movement I. e. ups and downs in this
chart and there isn't a clear indication of which direction this security is headed.

Regrettably, trends are not always easy to see. In simple words, defining a trend goes well
beyond what is normally visible to eyes. You will probably notice that in any given chart,
prices do not tend to move in a straight line in any particular direction, but rather it moves in
a series of highs and lows. It is the movement of these highs and lows that constitutes a trend
in technical analysis, For example, a downtrend is one of lower lows and lower highs while
an uptrend is classified as a series of higher highs and higher lows.
is an example of an uptrend. Point 2 in the chart is the first high, which is determined after
the price falls from this point. Point 3 is the low that is established as the price falls from the
high for this to remain an uptrend each successive low must not fall below the previous
lowest point or the trend is deemed a reversal.

Type of Trend
There are three types of trend

i} Up trends

ii) Downtrends

iii) Sideways/ Horizontal Trends

As the names imply, when each successive peak and trough is higher, it's referred to as an
upward trend. If the peaks and troughs are getting lower, it's downtrend. When there is little
movement up or down in the peaks and troughs, it's a sideways or horizontal trend. If you
want to get really technical, you might even say that a sideways trend is actually not a trend
on its own, but a lack of a well-defined trend in either direction. In any case, the market can
really trend in these three ways: up, down or nowhere.
Up & Down trend

Trend Lengths

An uptrend, down trend or horizontal trend can continue For long time period, short time
period or intermediate time period, accordingly & trend or trend of any direction can be
classified as a long-term trend intermediate trend or short-term trend. In terms of the stock
market, a major trend is generally categorized as one lasting longer than 12 months. An
intermediate trend is last between one month to a quarter of a year and a near-term trend is
anything less than a month. A long-term trend is composed of several. Intermediate trends,
which often move against the direction of the major trend. If the major trend is upward and
there is downward correction in price movement followed by a continuation of the correction
to be an intermediate trends.

When analysing trends, it is important that the chart is constructed to best reflect the type of
trend being analysed. To help identify long-term trends, wee charts or daily charts spanning a
five-year period are used by chartists to get a better idea of the long-term trend. Daily data
Charts analysing both intermediate and short-term trends. It is also important remember that
the longer the trend, the more important it is ; two month trend is not as significant as a two-
year trend.

Trendiness
A trend line is a simple charting technique that adds a line to a chart to represent the trend in
the market or a stock. Drawing a trend line is as simple as drawing a straight line that follows
a general trend. These lines are used to clearly show the trend and are also used in the
identification of trend reversals. As an upward trend line is drawn at the lows of an upward
trend. This line represents the support the stock has every time it moves from a high to a low.
Notice how the price is propped up by this support. This type of trend line helps traders to
anticipate the point at which a stock's price will begin moving upwards again. Similarly, a
downward trend line is drawn at the highs of the downward trend. This line represents the
resistance level that a stock faces every time the price moves from a low to a high.

Channels
A channel, or channel lines, is the addition of two parallel trend lines that act as strong areas
of support and resistance. The upper trend line connects a series of highs, while the lower
trend line connects a series of lows. A channel can slope upward, downward or sideways but,
regardless of the direction, the interpretation remains the same. Traders will expect a given
security to trade between the two levels of support and resistance until it breaks beyond one
of the levels, in which case traders can expect a sharp move in the direction of the break.
Along with clearly displaying the trend, channels are mainly used to illustrate important-areas
of support and resistance.

A descending channel on a stock chart; the upper trend line has been placed on the highs and
the · lower trend line is on. The lows the price has bounced off of these lines several times,
and has remained range- bound for several months. As long as the price does not fall below
the lower line or move beyond the upper resistance, the range-bound downtrend is expected
to continue.

It is important to be able to understand and identify trends so that you can trade with rather
than against them.

Support and Resistance

Once the concept of a trend is understood, the next major concept is that of support and
resistance. You must have often heard about bulls and the bears and the battle that goes
around between them, or the struggle between buyers (demand) and sellers (supply}. This is
revealed by the prices a security, seldom moves above (resistance) or below (support).
Support is the price level through which a stock or market rarely falls (denoted by the upward
arrows). Resistance, on the other hand is the price level that a stock or market rarely exceeds
denoted by the downward arrows).

Why does it happen?

These support and resistance levels are seen as important in terms of market Sentiments and
supply and demand. Support and resistance levels are the levels at which a lot of traders are
willing to buy the stock (in the case of a support) or sell it (in the case of resistance). When
these trend lines are broken. The supply and demand and the sentiments behind the stock's
movements is thought to have shifted , in which case new levels of support and resistance
will likely be established. This indicates major shifted in the price level of the security.

Head and Shoulders

This is one of the most popular and reliable chart patterns in technical analysis. It is a reversal
chart pattern that when formed, signals that the security is likely to move against. The
previous trend. As can be seen there are two versions of the head and shoulders chart pattern.
Head and shoulders top (shown on the left) is a chart pattern that is formed at the high of an
upward movement and signals that upward trend is about to end as against this. Head and
shoulders bottom which is also known as inverse head and shoulders (shown on the right) is
used to signal a reversal in a downtrend.

Both of these head and shoulders patterns are similar in that there are four main parts: two
shoulders, a head and a neckline. In addition to this, each individual head and shoulder is
comprised of a high and a Iow. For example, in the head and shoulders top image shown on
the left side in the is made up of a high followed by a low. In this pattern, the neckline is a
level of support or resistance. Remember that an upward trend is a period of successive rising
highs and rising lows. The head and shoulders chart pattern, therefore, indicates a weakening
in a trend by showing the deterioration in the successive movements of the highs and lows.
Fundamental Analysis

Fundamental analysis is the process of looking at a business at the most basic or

fundamental financial level. This type of analysis examines the key ratios of a
business to determine its financial health and it can give you an idea of the value of its
stock. It takes several factors into account, including revenue, asset management, and
the production of a business as well as interest rate.

Many investors use fundamental analysis alone, but it can be particularly helpful to
use it in combination with other tools to evaluate stocks for investment purposes. The
goal is to determine the current worth of the stock, and, perhaps more important, to
identify how the market values the stock.

Even if you don't plan to do an in-depth fundamental analysis yourself, understanding

the key ratios and terms can help you follow stocks more closely and accurately.

HOW DOES FUNDAMENTAL ANALYSIS WORK?

Fundamental analysis observes numerous elements that affect stock prices such as sales,
price to earnings (P/E) ratio, profits, earnings per share (EPS), as well as macroeconomic and
industry specific factors.

Fundamental analysts use either top-down or bottom-up methods of analysis, or sometimes

both.

A top-down analysis might function in the following manner:

1) The entire market is analysed, including global and macroeconomic indicators

2) The specific sector, such as Technology
3) The industry, for example semiconductor manufacturers
4) The specific stock, for example company ABC

Conversely, a bottom-up analysis starts by investigating specific stocks first.

The fundamental analyst observes trends, market and price movements, company financial
statements, interest rates, return on equity (ROE), and numerous other indicators with one
goal in mind: buying or selling stocks that will provide a high return on investment (ROI)

WHY DO FUNDAMENTAL ANALYSIS MATTER?

Fundamental analysis, like technical analysis, attempts to predict which stocks are valuable
and which are not. According to its proponents, fundamental analysis offers a fuller picture of
the possible movements of both the stock market and individual stocks because as many
elements as possible are investigated. Technical analysis, on the other hand, only looks at
past data of stock prices. Perhaps the greatest argument in favor of fundamental analysis can
be made by observing the success of one of its most famous proponents.
Strengths of Fundamental Analysis
Long-term Trends

Fundamental analysis is good for long-term investments based on very long-term trends. The
ability to identify and predict long-term economic, demographic, technological or consumer
trends can benefit patient investors who pick the right industry groups or companies.

Value Spotting

Sound fundamental analysis will help identify companies that represent a good value. Some
of the most legendary investors think long-term and value. Graham and Dodd, Warren
Buffett and John Neff are seen as the champions of value investing. Fundamental analysis
can help uncover companies with valuable assets, a strong balance sheet, stable earnings, and
staying power.

Business Acumen

One of the most obvious, but less tangible, rewards of fundamental analysis is the
development of a thorough understanding of the business. After such painstaking research
and analysis, an investor will be familiar with the key revenue and profit drivers behind a
company. Earnings and earnings expectations can be potent drivers of equity prices. Even
some technicians will agree to that. A good understanding can help investors avoid
companies that are prone to shortfalls and identify those that continue to deliver. In addition
to understanding the business, fundamental analysis allows investors to develop an
understanding of the key value drivers and companies within an industry. A stock's price is
heavily influenced by its industry group. By studying these groups, investors can better
position themselves to identify opportunities that are high-risk (tech), low-risk (utilities),
growth oriented (computer), value driven (oil), non-cyclical (consumer staples), cyclical
(transportation) or income-oriented (high yield).

Knowing Who's Who

Stocks move as a group. By understanding a company's business, investors can better

position themselves to categorize stocks within their relevant industry group. Business can
change rapidly and with it the revenue mix of a company. This happened to many of the pure
Internet retailers, which were not really Internet companies, but plain retailers. Knowing a
company's business and being able to place it in a group can make a huge difference in
relative valuations.
Weaknesses of Fundamental Analysis

Time Constraints
Fundamental analysis may offer excellent insights, but it can be extraordinarily time-
consuming. Time-consuming models often produce valuations that are contradictory to the
current price prevailing on Wall Street. When this happens, the analyst basically claims that
the whole street has got it wrong. This is not to say that there are not misunderstood
companies out there, but it seems quite brash to imply that the market price, and hence Wall
Street, is wrong.

Industry/Company Specific
Valuation techniques vary depending on the industry group and specifics of each company.
For this reason, a different technique and model is required for different industries and
different companies. This can get quite time-consuming, which can limit the amount of
research that can be performed. A subscription-based model may work great for an Internet
Service Provider (ISP), but is not likely to be the best model to value an oil company.

Subjectivity
Fair value is based on assumptions. Any changes to growth or multiplier assumptions can
greatly alter the ultimate valuation. Fundamental analysts are generally aware of this and use
sensitivity analysis to present a base-case valuation, an average-case valuation, and a worst-
case valuation. However, even on a worst-case valuation, most models are almost always
bullish, the only question is how much so. The chart below shows how stubbornly bullish
many fundamental analysts can be.

Amazon.com, Inc. (AMZN) Fundamental Analysis example chart from StockCharts.com

Analyst Bias
The majority of the information that goes into the analysis comes from the company itself.
Companies employ investor relations managers specifically to handle the analyst community
and release information. As Mark Twain said, “there are lies, damn lies, and statistics.” When
it comes to massaging the data or spinning the announcement, CFOs and investor relations
managers are professionals. Only buy-side analysts tend to venture past the company
statistics. Buy-side analysts work for mutual funds and money managers. They read the
reports written by the sell-side analysts who work for the big brokers (CIBC, Merrill Lynch,
Robertson Stephens, CS First Boston, Paine Weber, DLJ to name a few). These brokers are
also involved in underwriting and investment banking for the companies. Even though there
are restrictions in place to prevent a conflict of interest, brokers have an ongoing relationship
with the company under analysis. When reading these reports, it is important to take into
consideration any biases a sell-side analyst may have. The buy-side analyst, on the other
hand, is analyzing the company purely from an investment standpoint for a portfolio
manager. If there is a relationship with the company, it is usually on different terms. In some
cases, this may be as a large shareholder.

Definition of Fair Value

When market valuations extend beyond historical norms, there is pressure to adjust growth
and multiplier assumptions to compensate. If Wall Street values a stock at 50 times earnings
and the current assumption is 30 times, the analyst would be pressured to revise this
assumption higher. There is an old Wall Street adage: the value of any asset (stock) is only
what someone is willing to pay for it (current price). Just as stock prices fluctuate, so too do
growth and multiplier assumptions. Are we to believe Wall Street and the stock price or the
analyst and market assumptions?

It used to be that free cash flow or earnings were used with a multiplier to arrive at a fair
value. In 1999, the S&P 500 typically sold for 28 times free cash flow. However, because so
many companies were and are losing money, it has become popular to value a business as a
multiple of its revenues. This would seem to be OK, except that the multiple was higher than
the PE of many stocks! Some companies were considered bargains at 30 times revenues.

Conclusions
Fundamental analysis can be valuable, but it should be approached with caution. If you are
reading research written by a sell-side analyst, it is important to be familiar with the analyst
behind the report. We all have personal biases, and every analyst has some sort of bias. There
is nothing wrong with this, and the research can still be of great value. Learn what the ratings
mean and the track record of an analyst before jumping off the deep end. Corporate
statements and press releases offer good information, but they should be read with a healthy
degree of skepticism to separate the facts from the spin. Press releases don't happen by
accident; they are an important PR tool for companies.