definition – stock analysis:
Stock Analysis is a collection of methods used to predict future prices of assets in financial market. This is then used to make trading, investment or risk management decisions. Stock analysis can be divided into two major streams – Technical Analysis and Fundamental Analysis. However, they are not mutually exclusive.
Stock analysis methods are used by traders at investment banks, hedge funds and asset managers. Stock analysis methods are also used to forecast performance or build corporate strategy. In addition, they are used to estimate book value of assets held by a company on company balance sheet. Although, the methods might not be as complex as the ones used by traders at large investment banks.
This article is meant for traders, investors and (broadly) speculators who want to understand stock analysis for predicting future prices.
technical stock analysis
Technical analysis is a stock analysis method used to predict the future direction of prices through study of past patterns. This involves looking at past returns of the asset on a chart and drawing lines and waves through it. Generally speaking, it employs trading rules based on analysis of stock price and volume movement. Some examples are relative strength index, moving averages and regressions.
This method of stock analysis suffers from the assumption that all relevant information is priced in the market. Therefore a true believer of technical analysis looks at the history of a security or currency’s trading pattern. Rather than external drivers such as market data and news events.
fundamental stock analysis
Fundamental analysis, on the other hand, is based on cause and effect. In other words, any real asset has a true or fair value that depends on market data and news. The markets may incorrectly price a security in the short run, but, will eventually, find the “correct” price. So, we buy an underpriced asset cheap. And we sell an overpriced asset. Once the prices correct themselves, we exit the position, and make a profit.
When done correctly, this is a scientific approach to stock analysis. The real world has a number of variables, that interact with each other and impact the markets. Hence, we cannot perform fundamental stock analysis manually on a piece of paper or chart. It requires access to high compute power to run algorithms on large volumes of data. This also requires access to real time data and news feeds. Since, these are not freely available on the internet, running these algos can get expensive very quickly. Hence the best algorithms are only accessible to large investment banks, hedge funds and asset managers.
STOKAI aims to democratise fundamental stock analysis models, by making them accessible to everyone.
example: Dow Futures fundamental analysis
dollar(USD) rate in fx markets
Firstly, as USD rises in value, this causes a drop in foreign investment. Because foreign investors get less USD for their currency. Hence, large global investors will not use their USD reserves to buy US stocks. But, convert USD into their local currency as they will get more of their local currency per US Dollar. On the other hand, fall in value of USD will make Dow stocks cheaper, causing Dow Futures to rise.
Secondly, higher inflation causes fall in the value of USD. So, US companies are able to sell their goods and services at higher prices. Therefore, the futures, that are close to expiry will rise, as companies are bringing in more cash. However, this will then, translate to higher employee wages and higher cost of goods and raw materials. Hence, high inflation over a sustained period of time, will cause longer dated Futures contract to drop in price.
Thirdly, short and medium term interest rates spike will be used in fundamental stock analysis of the Futures market. This is because higher rates will mean a (relatively)risk free alternative to stocks in the short term. Hence, this will cause Futures contracts, that are close to expiry, to drop. However, long term high rates will lower bond yields. Therefore, the large investors’ money will move to stocks, causing long dated Futures price to spike.
and the rest
Finally, we use unemployment rate and PMI(Purchasing Managers Index) in fundamental stock analysis of Dow Futures. For instance, high unemployment rate will lead to lower disposable incomes. Consequently, this will cause a drop in consumer demand and this would cause a downward trend for stocks. In contrast, a higher PMI in the US will mean an increase in economic activity. This will lead to higher employment and a high demand for goods and services produced by Dow Jones companies. So, this will increase the value of Dow Futures.
While these are some of the basic stock analysis factors, the list is not complete. In addition, we should account for correlation between these factors as the first step in stock analysis.
It is important to spend some time learning the history and basics. This time spent will yield dividends when you are trying to predict movement of an asset. Also remember that you are more rational before you place a trade. So, it’s important to set some rules. If you like market conditions and they fit what your rules suggest, go for it. If the conditions for the rules don’t fit what you see in the markets, don’t trade for it’s own sake. You don’t have to trade every day. The point of having rules is to run them to your favour, and not let them run you.
Day trading follows the same rules we use for life. Successful trading is the art of using knowledge and skills at the right time. It is also essential to set some limits once you open a position. For example, you may impose a limit on yourself to not keep a trade open for more than 20 days. Finally get access to good tools that can help you achieve your trading goals. It’s best to try out a lot of things on paper money accounts before risking your capital.
Despite of all the rules, limits and right mindset, random events will happen. So always have a contingency plan. A perfect system or rules don’t exist. And, this is a good thing. Otherwise, someone will work it out and own half of the free world. All algorithms, tools, systems and rules are based on a snapshot of data. So always pay attention to news and data on a given day.
how to apply this to trading
STOKAI provides daily prediction using fundamental stock analysis and evolves this over 10 days in the future. Tutorial and brief user guide is available here – Tutorial. If there are any issues, please contact our customer services team.
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