How do you decide whether to buy the stock of company A
or company B? Or be-tween investing your money in Singapore
or Malaysia? The two commonly used approaches for such
decisions are Technical Analysis and Fundamental Analysis.
This article will introduce you to both approaches and their
principles.
When technical analysis is mentioned, people often
think of analysts plotting price movements of stocks,
drawing lines to find trends, support or resistance.
Technical analysis is the art of deducing probable
future trend from historical records of stock trading. It
is the study of the stock market itself rather than the
external factors that influence the market. The most
familiar indicators used are the price and volume of a
stock.
Advocates of technical analysis believe that information
is not immediately reflected in the market prices of stocks.
For example, when a piece of good news about a company is
available, it is not immediately known to everyone but is
slowly passed from one person to another. This process
takes time and an upward price trend develops for that
company as more and more people hear the good news and want
to buy the stock and fewer and fewer people are willing to
sell the stock. The stock price which has started to move
in an uptrend will continue to do so until something happens
to change the supply-demand balance. For the technical
analyst, he does not need to know what the good news or any
other information that is affecting the stock price is; the
chart will tell him whether the stock price is going to move
up or down. He does not need to know the fundamentals of
the company because if the price is going up, the
fundamentals must be improving.
On the other hand, fundamental analysis examines all
relevant factors affecting the stock price in order to
determine an intrinsic value for that stock. If the market
price is below the intrinsic value, then the stock is
undervalued and should be bought. The factors to consider
include balance sheet items, corporate management, business
prospects and earnings outlook. The fundamental analyst
calculates financial ratios based on data available from the
balance sheet and income statement of a company. From these
ratios, he deduces the financial strength and earnings trend
of the company. Then he will meet the company's management
to affirm his deductions, to understand the business and to
learn of any new development of the company and the
industry.
A widely used tool in fundamental analysis is the
price-earnings ratio or PE ratio. It is calculated using
the stock price divided by the earnings per share (EPS) of a
company. As a general rule, a stock with a low PE ratio is
considered cheap although there are difficulties in applying
this principle. PE ratios of two companies can only be
compared if the companies are similar. It is believed that
companies in different industries deserve different PE
ratios. For example, Singapore Telecom is believed to
deserve a higher PE ratio than many other stocks because of
its position in the telecommunication business. However,
analysts have not yet agreed on what PE ratio each industry
or company deserves and there is no one way to determine the
right PE ratio.
Both approaches attempt to predict the future price
movement of a stock. Fundamentalists study the cause of
market movement while technicians believe that the effect is
all that they need to know. Despite their differences, both
approaches try to increase your probability of picking up
the right stock at a right price. However, these methods
only increase your chances but do not guarantee complete
success. Some believe that fundamental analysis is good for
picking the right stock while technical analysis is
appropriate to decide the right price or time to buy.
For the professional investor, he has to take another
step of deciding the sequence of analysis. This will have
an impact on how the investor divides his money among
different countries and stocks. Basically, the investor
decides whether the market as a whole or the com
