Find Stock Market Bearish Or Not

Find Stock Market Bearish Or Not

Wall Street professionals don’t just look at the major indexes to see if the market has hit a bottom. They look at other indicators too.

Has the stock market hit bottom? Have stocks found support? When will prices stop falling?

Stock traders ask these questions every day, but they keep looking in the wrong place to find the answers. Investors seem to be transfixed on the value of the Dow Jones Industrial Average (DJIA), but the value of the Dow isn’t going to tell you when the stock market has found a bottom—at least not until well after the fact, that is. You need to look at other indicators to determine when the stock market is going to find a bottom and start moving higher if you don’t want to miss the initial surge. In this article, I’ll cover five such indicators.

I referred to these indicators as “secret” indicators in the title, but I don’t mean secret as in a “wall-street-fat-cats-conspiracy” kind of secret. I mean secret as in an “individual-investors-tend-not-to-know-about-these-indicators” kind of secret. But once you are done with this article, you will know about these indicators and how to use them.

Here are the five indicators you can use to help you determine when the stock market is likely to form a bottom:

- TED Spread
- Baltic Dry Index
- NYSE Margin Debt
- Bullish Percent Index
- Short Interest

The first two indicators look at the health of the global economy, and the last three look at what the major players in the stock market are actually doing with their money. So let’s get started.

TED Spread
The TED Spread gives you a snapshot of how healthy the global credit market is. The credit market is going to have to thaw and begin functioning in a healthy manner before the stock market can truly rebound and begin climbing again.

The TED spread measures the difference between the yield on the 3-month Treasury Bill (T-bill) and the value of the eurodollar futures contract—which is based on the 3-month LIBOR rate. To calculate the TED spread, you simply subtract the yield on the 3-month T-bill from the value of the eurodollar contract. For instance if the value of the eurodollar contract is at 3.75 percent and the yield on the 3-month T-bill is at 2.25 percent, the TED spread is 1.50 percent, or 150 basis points (3.75 – 2.25 = 1.50).

You will most likely see the TED Spread narrowing before the stock market finds a bottom.

Baltic Dry Index
The Baltic Dry Index is a leading indicator that provides a clear view into the global demand for commodities and raw materials. The fact that the Baltic Dry Index focuses on raw materials is important because demand for raw materials provides a glimpse into the future. Typically, demand for commodities and raw goods increases when global economies are growing. For investors, knowing when the global economy is growing is helpful because that means stock prices, commodity prices and the value of commodity-based currencies should be increasing. Conversely, demand for commodities and raw goods decreases when global economies are stalling or contracting. For investors, knowing when the global economy is contracting is helpful because that means stock prices, commodity prices and the value of commodity-based currencies should be decreasing.

The Baltic Dry Index (BDI) is a measure of what it costs to ship raw materials—like iron ore, steel, cement, coal and so on—around the world. The Baltic Dry Index is compiled daily by The Baltic Exchange. To compile the index, members of the Baltic Exchange call dry bulk shippers around the world to see what their prices are for 22 different shipping routes around the globe. Once they have obtained these numbers, they compile them and find an average.

You will most likely see a surge in the value of the Baltic Dry Index—showing a surge in production—before the stock market finds a bottom.

NYSE Margin Debt
The NYSE Margin Debt number gives you an idea of how confident stock traders are in the prospect of stocks increasing in value.

Buying stocks using borrowed money from your broker is called buying stock on margin. Every month, the New York Stock Exchange (NYSE) releases numbers showing how much money was borrowed on margin to buy stocks on the NYSE.

As you can imagine, the amount of stock bought on margin is extremely large, but the total number fluctuates quite a bit based on how confident traders are. When stock traders are confident, they borrow more on margin. When stock traders are less confident, they borrow less on margin.

You will most likely see an increase in margin borrowing once the stock market finds a bottom.

S&P 500 Bullish Percent Index
The S&P 500 Bullish Percent Index gives you a much broader picture of just how many stocks are moving higher than you can get by looking at the value of the Dow Jones Industrial Average or the S&P 500.

The S&P 500 Bullish Percent Index is a point-and-figure chart that derives its value from the point-and-figure charts of the 500 stocks that comprise the S&P 500. Here’s how it works:

- If an increasing number of those 500 stocks are showing buy signals on their point-and-figure charts, the S&P 500 Bullish Percent Index will be moving higher.

- If an increasing number of those 500 stocks are showing sell signals on their point-and-figure charts, the S&P 500 Bullish Percent Index will be moving lower.

You will most likely see a broad number of stocks—not just a few select shares—increasing in value once the stock market finds a bottom.

Short Interest
Monitoring the short interest in the stocks you are interested in buying will give you a good idea what the investor sentiment toward those stocks is.

Short interest is the number of shares that investors are currently short on a particular stock.

For instance, if stock traders shorted 15 million shares of a company and then covered 5 million shares by buying the stock back, the current short interest would be 10 million shares (15 million – 5 million = 10 million).

You will most likely see the short interest in major stocks decline once the stock market finds a bottom.

Conclusion
While no indicator is a magic bullet for identifying a market bottom, monitoring a few broad economic indicators can give you a good idea of how healthy the global economy and the stock market are.

After all, stocks go up when the companies represented by those stocks do well, and companies tend to do well when the global economy is healthy and functioning correctly.

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Risk and Diversification

While the stock market may be lucrative, the market can be volatile, with the ups and downs of the proverbial roller coaster. Every individual investor has a different threshold for the level of risk they are willing to take on in their investments. In fact, your personality and lifestyle may dictate how much risk you will be able to stomach comfortably.

Each investment instrument has varying degrees of risk associated with it. As an investor, you must consider the risks involved, and have the knowledge to protect yourself from these risks.

In this tutorial, you will be introduced to risk and its relationship to making profit from your investment.

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Economic Indicators: Retail Sales Report

What It Is

The Retail Sales Report is an indicator that follows the dollar value of merchandise sold within the retail trade. Samples are taken from companies that engage in selling products to end-consumers. The report is closely monitored by economists and investors.

Basic Information

The retail sales report includes in its data sample both fixed point-of-sale businesses and non-store retailers. The survey is not limited to large retailers alone. Stores as big as Wal-mart down to “mom and pop” businesses are taken into account in the survey. The report has two main components: total sales figures and ex-autos.

The report is considered a coincident indicator, and is a good measure of the performance of the retail industry and the price level activity in general. The data covered is the previous month’s sales. Consumer spending accounts for about two-thirds of the total GDP, so activity in the retail industry reflects the current conditions of the economy, and as such, Wall street watchers and the Conference Review Board are very interested in it. The retail sales report is also considered a very important pre-inflationary indicator.

How the Report Is Valuable

Information in the Retail Sales Report can cause volatility in the stock market that is above normal. It is seen by investors as a predictor of inflation causing them to consider the possibility of Fed rate cuts or hikes. For example, to try to prevent inflation, the Fed will extend a short-term increase in interest rates in case there is sharp rise in retail sales in the middle of a business cycle. When this happens, investors normally sell bonds causing yields to go up. This will in turn cause problems for stocks since inflation causes decreased future cash flows for companies.

Conversely, a slow activity in the retail market means that consumers are not spending too much and is an indicator for a recession.

Perhaps the most important thing that the report is used for is to measure its reported figure against the consensus number or “street number”. Results that are higher than exepected can provoke investors to unload their stocks and bonds in fear of inflation.

Things to Watch Out For

The released data covers all sectors of the retail industry which gives investors an idea of how their investments (in retail stocks) are performing, regardless of the state of the overall market. Retail companies, because of this, become extremely volatile when the report is released to the public.

What the report does not include is retail services, therefore not all retail activity is truly covered. Retails sales data can vary highly from one month to another making it difficult to predict a trend.

Despite this, retail sales is still a very important indicator of the performance of the economy, and it’s detailed information on the retail industry has a large influence on the market.

Read more at http://www2.thestockmarketwatch.com/learn-stock-market/economic-indicators-retail-sales-report/#3ZaUfGT3WLeb8xsD.99

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Moving Average Of Stock Market

Moving Averages

● What Are Moving Averages? Simply put, a moving average (MA) is the average of a stock price over a set period of time. For example, a 10 day moving average is the average of the last 10 day’s prices. Moving averages can be set to any period of time. If you are looking at a weekly chart instead of a daily chart, the moving average will average each week’s price as opposed to each day’s. Below is a daily chart of Cisco Systems (CSCO) with a 20 day moving plotted over it. Fig 3.1 Click to Enlarge. The 20 day moving average creates a smoothing effect. It allows one to see the general trend without getting distracted by choppiness or extreme moves. Sometimes moving averages are used to replace trend lines. ● How to Use a Single Moving Average Spotting the Trend One use of a single moving average to trade stocks is to spot the trend. The longer you make the moving average, the longer the trend it will tell of. For example, a 5 day MA may be relevant to someone wanting to trade stocks in terms of a few days, but a 200 day MA might be relevant to someone wanting to invest for years. Below is a weekly chart of the Dow Jones Industrial Average with a 50 week MA plotted over it. Fig 3.2 Click to Enlarge. Each point on the 50 week MA is the average of the past 50 weeks of price data. Just taking a quick glance reveals that the Dow Jones, around 2000, switched from an uptrend to a downtrend. This chart, because it’s a weekly chart dealing with a fairly long-term moving average, would be relevant to someone investing in terms of years. (What exactly constitutes a “long” moving average is somewhat arbitrary and is ultimately to product of your own judgment and experience.)            ● Above or Below the Moving Average? Another use of a single moving average is to see if the price is above or below it. If the price is trading above its moving average, it’s considered a bullish sign. If a stock is trading below its moving average, it’s considered a bearish sign. Again, what the length of the moving average is depends on your timeframe for trading. Below is a weekly chart of the NASDAQ Index from ’95 to late ’99, which is the greater part of its famous move up. Fig 3.3 Click to Enlarge. Notice that during that move up, the NASDAQ stayed above its 50 week MA for almost the entire time. Many stocks that experience strong moves up stay above their moving averages for extended periods of time. Any break below it can signal trouble. ● How to Trade Stocks Use Multiple Moving Averages The Crossover A common way of using multiple moving averages is the crossover. In its simplest form, the crossover consists of two moving averages, one being shorter than the other. When the shorter one crosses below the longer one, it’s a bearish sign. When the shorter one crosses above the longer one, it’s a bullish sign. Look at the weekly chart of the NASDAQ Index in figure 3.4 below. Fig 3.4 Click to Enlarge. As you can see in the chart, from ’97 all the way until mid ’00, the NASDAQ’s 20 week moving average (red) stayed above its 50 week moving average (blue). When the 20 day MA crossed below the 50 day MA, a bearish crossover occurred, and the NASDAQ subsequently broke down.

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Indicator Find Oscillation about Stockmarket

Oscillators

● What Are They? An oscillator is a kind of stock market indicator that gives you trading signals. Chart programs generate them for you automatically. All you have to do is read them. Like most things in this guide, we will only go over the most widely-used and accepted ones. We will also not go into the mathematics behind the oscillators, but if you would like to learn, references will be listed. Stochastics   Fig 3.7 Click to Enlarge. Notice that for Stochastics, 80 is the overbought level and 20 is the oversold level. Common usage dictates that if the lines go above 80, then the stock will likely drop. If the lines go below 20, then the stock will likely go up. Another common usage of Stochastics is to buy when the K line (blue) crosses above the D line (red) and sell when the opposite happens. MACD MACD, which stands for “Moving Average Convergeance/Divergeance,” is another stock market indicator generator just like Stochastics, but it looks and acts slightly differently. Take a look below.   Fig 3.8 Click to Enlarge. The most common usage of MACD is to buy when the pink bars cross above the middle “signal” line, and sell when they cross below. Another way to use MACD is to establish your own overbought and oversold levels such as + 0.5 and - 0.5, then buy and sell according to the red and blue lines. RSI RSI, which stands for “Relative Strength Index,” is a stock market indicator developed by Welles Wilder in 1979. It was originally intended for use in commodities, but was found to be useful in stocks as well.   Fig 3.9 Click to Enlarge. For the RSI, overbought and oversold levels are usually set at 70 and 30. When price goes above 70, it’s considered overbought, and when it goes below 30, it’s considered oversold. Another way of using RSI is to look for divergences between the oscillator and the price. For example, if the price makes a new high, but the RSI fails to, it could signal an impending reversal.   Helpful Hints for Using Oscillators:  Overbought and oversold levels work beautifully in a trading range, but they can be disastrous if used wrongly in a trend. During trends, the oscillators can read overbought or oversold for extended periods of time. So never take an oversold reading alone to mean that it’s time to buy.  If a stock or currency is in the middle of a strong downtrend, the oversold indicator could stay that way for years. So before you use an oscillator, first assess whether or not whatever you’re looking at is in a trend. If it’s trending, then it’s best to use overbought/oversold readings to time your entry and exits as you trade WITH the trend. So, for example, if you notice a strong uptrend, then so long as the uptrend is still valid, use oversold levels as entry points, and overbought levels for exit points. No oscillator is perfect. You’ll never find the magic oscillator which gives completely accurate signals all the time. This is a game of probability. You want to use oscillators to increase your chances. The best way to use oscillator signals is to combine them with other technical analysis readings. For example, if you notice a stock is bouncing off a resistance level, and the RSI reads overbought, then you might want to sell. Making decisions using a combination of factors increases your chances of winning. There are over a hundred oscillators that exist. Some are popular some aren’t. You can even create your own oscillators on certain chart programs. Become familiar with the popular ones first, then venture into the unknown if you’d like.

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Stock Market Safety Index

Stock Market Safety Index

We use the Stock Market Safety Index (MSI) as an indicator of the market's condition. Its main purpose is to tell us whether the market is overvalued or undervalued. We compute the MSI by taking the difference between an extrapolated SP500 earnings yield and the current 90-day TBILL discount interest rate. The extrapolation is 13 weeks and computed with a constrained quadratic least-squares fit of the preceding 52 weeks of earnings. A MSI value greater than zero means that the equities yield is higher than the TBILL yield and the market is undervalued. A MSI value less than zero implies that the equities yield is lower than the TBILL yield and the market is overvalued. In terms of return and risk, a large positive value would favor stocks as an investment. A large negative value would favor less risky investments, such as TBILLs. If you look at plot of the MSI over the past it is easy to pick out the 1987 crash, the 1990 mini-crash, and the 2001 decline. In all three cases, stocks fell in value and the MSI quickly went from a large negative number to a positive one. Using these three events, it appears that when the MSI is less than negative 2.0, the market is extremely overvalued and is vulnerable to a correction. Accordingly, we ignore our market forecast and remain in CASH when the MSI is less than negative 2.0. The MSI graph shown below includes the most recent data (updated weekly). Draw your own conclusion as to the condition of today's market.

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Technical Analysis: Introduction

The methods used to analyze securities and make investment decisions fall into two very broad categories: fundamental analysis and technical analysis. Fundamental analysis involves analyzing the characteristics of a company in order to estimate its value. Technical analysis takes a completely different approach; it doesn't care one bit about the "value" of a company or a commodity. Technicians (sometimes called chartists) are only interested in the price movements in the market.

Despite all the fancy and exotic tools 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. In other words, technical analysis attempts to understand the emotions in the market by studying the market itself, as opposed to its components. If you understand the benefits and limitations of technical analysis, it can give you a new set of tools or skills that will enable you to be a better trader or investor.

In this tutorial, we'll introduce you to the subject of technical analysis. It's a broad topic, so we'll just cover the basics, providing you with the foundation you'll need to understand more advanced concepts down the road. 

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What is Fundamental Analysis?

Fundamental analysis is a method that attempts to predict the intrinsic value of an investment. It is based on the theory that the market price of an asset tends to move towards its 'real value' or 'intrinsic value'.
Fundamental analysis in Forex entails predicting the price valuation of a currency and its market trends by analyzing current economic conditions, government policy and societal factors within a business cycle framework. Forex Traders gauge a country's economic state by examining macroeconomic indicators covering:

• Interest Rates Announcement
• Gross Domestic Product (GDP)
• Consumer Price Index (Inflation) and Spending Indicators
• Employment Indicators
• Retail Trade and Consumer Confidence
• Balance of Trade Surplus or Deficit
• Government Fiscal and Monetary Policy

Visit our economic indicators page and learn more about the different indicators and their impacts on the markets.

Fundamental Analysis Benefits

Determining the intrinsic value of an investment
Identifying long-term investment opportunities

Fundamental Analysis Drawbacks

Too many macroeconomic indicators and indicator can confuse novice investors

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Fundamental Analysis 2

Fundamental Analysis

What is Fundamental Analysis?

Fundamental analysis is the examination of the underlying forces that affect the well being of the economy, industry groups, and companies. As with most analysis, the goal is to derive a forecast and profit from future price movements. At the company level, fundamental analysis may involve examination of financial data, management, business concept and competition. At the industry level, there might be an examination of supply and demand forces for the products offered. For the national economy, fundamental analysis might focus on economic data to assess the present and future growth of the economy. To forecast future stock prices, fundamental analysis combines economic, industry, and company analysis to derive a stock's current fair value and forecast future value. If fair value is not equal to the current stock price, fundamental analysts believe that the stock is either over or under valued and the market price will ultimately gravitate towards fair value. Fundamentalists do not heed the advice of the random walkers and believe that markets are weak-form efficient. By believing that prices do not accurately reflect all available information, fundamental analysts look to capitalize on perceived price discrepancies.

General Steps to Fundamental Evaluation

Even though there is no one clear-cut method, a breakdown is presented below in the order an investor might proceed. This method employs a top-down approach that starts with the overall economy and then works down from industry groups to specific companies. As part of the analysis process, it is important to remember that all information is relative. Industry groups are compared against other industry groups and companies against other companies. Usually, companies are compared with others in the same group. For example, a telecom operator (Verizon) would be compared to another telecom operator (SBC Corp), not to an oil company (ChevronTexaco).

Economic Forecast

First and foremost in a top-down approach would be an overall evaluation of the general economy. The economy is like the tide and the various industry groups and individual companies are like boats. When the economy expands, most industry groups and companies benefit and grow. When the economy declines, most sectors and companies usually suffer. Many economists link economic expansion and contraction to the level of interest rates. Interest rates are seen as a leading indicator for the stock market as well. Below is a chart of the S&P 500 and the yield on the 10-year note over the last 30 years. Although not exact, a correlation between stock prices and interest rates can be seen. Once a scenario for the overall economy has been developed, an investor can break down the economy into its various industry groups.

Group Selection

If the prognosis is for an expanding economy, then certain groups are likely to benefit more than others. An investor can narrow the field to those groups that are best suited to benefit from the current or future economic environment. If most companies are expected to benefit from an expansion, then risk in equities would be relatively low and an aggressive growth-oriented strategy might be advisable. A growth strategy might involve the purchase of technology, biotech, semiconductor and cyclical stocks. If the economy is forecast to contract, an investor may opt for a more conservative strategy and seek out stable income-oriented companies. A defensive strategy might involve the purchase of consumer staples, utilities and energy-related stocks.
To assess a industry group's potential, an investor would want to consider the overall growth rate, market size, and importance to the economy. While the individual company is still important, its industry group is likely to exert just as much, or more, influence on the stock price. When stocks move, they usually move as groups; there are very few lone guns out there. Many times it is more important to be in the right industry than in the right stock! The chart below shows that relative performance of 5 sectors over a 7-month time frame. As the chart illustrates, being in the right sector can make all the difference.

Narrow Within the Group

Once the industry group is chosen, an investor would need to narrow the list of companies before proceeding to a more detailed analysis. Investors are usually interested in finding the leaders and the innovators within a group. The first task is to identify the current business and competitive environment within a group as well as the future trends. How do the companies rank according to market share, product position and competitive advantage? Who is the current leader and how will changes within the sector affect the current balance of power? What are the barriers to entry? Success depends on an edge, be it marketing, technology, market share or innovation. A comparative analysis of the competition within a sector will help identify those companies with an edge, and those most likely to keep it.

Company Analysis

With a shortlist of companies, an investor might analyze the resources and capabilities within each company to identify those companies that are capable of creating and maintaining a competitive advantage. The analysis could focus on selecting companies with a sensible business plan, solid management and sound financials.

Business Plan

The business plan, model or concept forms the bedrock upon which all else is built. If the plan, model or concepts stink, there is little hope for the business. For a new business, the questions may be these: Does its business make sense? Is it feasible? Is there a market? Can a profit be made? For an established business, the questions may be: Is the company's direction clearly defined? Is the company a leader in the market? Can the company maintain leadership?

Management

In order to execute a business plan, a company requires top-quality management. Investors might look at management to assess their capabilities, strengths and weaknesses. Even the best-laid plans in the most dynamic industries can go to waste with bad management (AMD in semiconductors). Alternatively, even strong management can make for extraordinary success in a mature industry (Alcoa in aluminum). Some of the questions to ask might include: How talented is the management team? Do they have a track record? How long have they worked together? Can management deliver on its promises? If management is a problem, it is sometimes best to move on.

Financial Analysis

The final step to this analysis process would be to take apart the financial statements and come up with a means of valuation. Below is a list of potential inputs into a financial analysis.

Accounts Payable Accounts Receivable Acid Ratio Amortization Assets - Current Assets - Fixed Book Value Brand Business Cycle Business Idea Business Model Business Plan Capital Expenses Cash Flow Cash on hand Current Ratio Customer Relationships Days Payable Days Receivable Debt Debt Structure Debt:Equity Ratio Depreciation Derivatives-Hedging Discounted Cash Flow Dividend Dividend Cover Earnings EBITDA Economic Growth Equity Equity Risk Premium Expenses

Good Will Gross Profit Margin Growth Industry Interest Cover International Investment Liabilities - Current Liabilities - Long-term Management Market Growth Market Share Net Profit Margin Pageview Growth Pageviews Patents Price/Book Value Price/Earnings PEG Price/Sales Product Product Placement Regulations R & D Revenues Sector Stock Options Strategy Subscriber Growth Subscribers Supplier Relationships Taxes Trademarks Weighted Average Cost of Capital

The list can seem quite long and intimidating. However, after a while, an investor will learn what works best and develop a set of preferred analysis techniques. There are many different valuation metrics and much depends on the industry and stage of the economic cycle. A complete financial model can be built to forecast future revenues, expenses and profits or an investor can rely on the forecast of other analysts and apply various multiples to arrive at a valuation. Some of the more popular ratios are found by dividing the stock price by a key value driver.

Ratio Price/Book Value Price/Earnings Price/Earnings/Growth Price/Sales Price/Subscribers Price/Lines Price/Page views Price/Promises

Company Type Oil Retail Networking B2B ISP or cable company Telecom Web site Biotech

This methodology assumes that a company will sell at a specific multiple of its earnings, revenues or growth. An investor may rank companies based on these valuation ratios. Those at the high end may be considered overvalued, while those at the low end may constitute relatively good value.

Putting it All Together

After all is said and done, an investor will be left with a handful of companies that stand out from the pack. Over the course of the analysis process, an understanding will develop of which companies stand out as potential leaders and innovators. In addition, other companies would be considered laggards and unpredictable. The final step of the fundamental analysis process is to synthesize all data, analysis and understanding into actual picks.

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 is 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.

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. Investors should become skilled readers to weed out the important information and ignore the hype.

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Technical Analysis

What is Technical Analysis?

 

Technical Analysis is the forecasting of future financial price movements based on an examination of past price movements. Like weather forecasting, technical analysis does not result in absolute predictions about the future. Instead, technical analysis can help investors anticipate what is "likely" to happen to prices over time. Technical analysis uses a wide variety of charts that show price over time.


Technical analysis is applicable to stocks, indices, commodities, futures or any tradable instrument where the price is influenced by the forces of supply and demand. Price refers to any combination of the open, high, low, or close for a given security over a specific time frame. The time frame can be based on intraday (1-minute, 5-minutes, 10-minutes, 15-minutes, 30-minutes or hourly), daily, weekly or monthly price data and last a few hours or many years. In addition, some technical analysts include volume or open interest figures with their study of price action.

The Basis of Technical Analysis

At the turn of the century, the Dow Theory laid the foundations for what was later to become modern technical analysis. Dow Theory was not presented as one complete amalgamation, but rather pieced together from the writings of Charles Dow over several years. Of the many theorems put forth by Dow, three stand out:

• Price Discounts Everything
• Price Movements Are Not Totally Random
• "What" Is More Important than "Why"

Price Discounts Everything

This theorem is similar to the strong and semi-strong forms of market efficiency. Technical analysts believe that the current price fully reflects all information. Because all information is already reflected in the price, it represents the fair value, and should form the basis for analysis. After all, the market price reflects the sum knowledge of all participants, including traders, investors, portfolio managers, buy-side analysts, sell-side analysts, market strategist, technical analysts, fundamental analysts and many others. It would be folly to disagree with the price set by such an impressive array of people with impeccable credentials. Technical analysis utilizes the information captured by the price to interpret what the market is saying with the purpose of forming a view on the future.

Prices Movements are not Totally Random

Most technicians agree that prices trend. However, most technicians also acknowledge that there are periods when prices do not trend. If prices were always random, it would be extremely difficult to make money using technical analysis. In his book, Schwager on Futures: Technical Analysis, Jack Schwager states:
"One way of viewing it is that markets may witness extended periods of random fluctuation, interspersed with shorter periods of nonrandom behavior. The goal of the chartist is to identify those periods (i.e. major trends)."

A technician believes that it is possible to identify a trend, invest or trade based on the trend and make money as the trend unfolds. Because technical analysis can be applied to many different time frames, it is possible to spot both short-term and long-term trends. The IBM chart illustrates Schwager's view on the nature of the trend. The broad trend is up, but it is also interspersed with trading ranges. In between the trading ranges are smaller uptrends within the larger uptrend. The uptrend is renewed when the stock breaks above the trading range. A downtrend begins when the stock breaks below the low of the previous trading range.

"What" is More Important than "Why"

In his book, The Psychology of Technical Analysis, Tony Plummer paraphrases Oscar Wilde by stating, "A technical analyst knows the price of everything, but the value of nothing". Technicians, as technical analysts are called, are only concerned with two things:

1. What is the current price?
2. What is the history of the price movement?

The price is the end result of the battle between the forces of supply and demand for the company's stock. The objective of analysis is to forecast the direction of the future price. By focusing on price and only price, technical analysis represents a direct approach. Fundamentalists are concerned with why the price is what it is. For technicians, the why portion of the equation is too broad and many times the fundamental reasons given are highly suspect. Technicians believe it is best to concentrate on what and never mind why. Why did the price go up? It is simple, more buyers (demand) than sellers (supply). After all, the value of any asset is only what someone is willing to pay for it. Who needs to know why?

General Steps to Technical Evaluation

Many technicians employ a top-down approach that begins with broad-based macro analysis. The larger parts are then broken down to base the final step on a more focused/micro perspective. Such an analysis might involve three steps:

1. Broad market analysis through the major indices such as the S&P 500, Dow Industrials, NASDAQ and NYSE Composite.
2. Sector analysis to identify the strongest and weakest groups within the broader market.
3. Individual stock analysis to identify the strongest and weakest stocks within select groups.

The beauty of technical analysis lies in its versatility. Because the principles of technical analysis are universally applicable, each of the analysis steps above can be performed using the same theoretical background. You don't need an economics degree to analyze a market index chart. You don't need to be a CPA to analyze a stock chart. Charts are charts. It does not matter if the time frame is 2 days or 2 years. It does not matter if it is a stock, market index or commodity. The technical principles of support, resistance, trend, trading range and other aspects can be applied to any chart. While this may sound easy, technical analysis is by no means easy. Success requires serious study, dedication and an open mind.

Chart Analysis

Technical analysis can be as complex or as simple as you want it. The example below represents a simplified version. Since we are interested in buying stocks, the focus will be on spotting bullish situations.

Overall Trend: The first step is to identify the overall trend. This can be accomplished with trend lines, moving averages or peak/trough analysis. As long as the price remains above its uptrend line, selected moving averages or previous lows, the trend will be considered bullish.
Support: Areas of congestion or previous lows below the current price mark support levels. A break below support would be considered bearish.
Resistance: Areas of congestion and previous highs above the current price mark the resistance levels. A break above resistance would be considered bullish.
Momentum: Momentum is usually measured with an oscillator such as MACD. If MACD is above its 9-day EMA (exponential moving average) or positive, then momentum will be considered bullish, or at least improving.
Buying/Selling Pressure: For stocks and indices with volume figures available, an indicator that uses volume is used to measure buying or selling pressure. When Chaikin Money Flow is above zero, buying pressure is dominant. Selling pressure is dominant when it is below zero.
Relative Strength: The price relative is a line formed by dividing the security by a benchmark. For stocks it is usually the price of the stock divided by the S&P 500. The plot of this line over a period of time will tell us if the stock is outperforming (rising) or under performing (falling) the major index.
The final step is to synthesize the above analysis to ascertain the following:

• Strength of the current trend.
• Maturity or stage of current trend.
• Reward to risk ratio of a new position.
• Potential entry levels for new long position.

Top-Down Technical Analysis

For each segment (market, sector and stock), an investor would analyze long-term and short-term charts to find those that meet specific criteria. Analysis will first consider the market in general, perhaps the S&P 500. If the broader market were considered to be in bullish mode, analysis would proceed to a selection of sector charts. Those sectors that show the most promise would be singled out for individual stock analysis. Once the sector list is narrowed to 3-4 industry groups, individual stock selection can begin. With a selection of 10-20 stock charts from each industry, a selection of 3-4 of the most promising stocks in each group can be made. How many stocks or industry groups make the final cut will depend on the strictness of the criteria set forth. Under this scenario, we would be left with 9-12 stocks from which to choose. These stocks could even be broken down further to find the 3-4 of the strongest of the strong.

Strengths of Technical Analysis

Focus on Price

If the objective is to predict the future price, then it makes sense to focus on price movements. Price movements usually precede fundamental developments. By focusing on price action, technicians are automatically focusing on the future. The market is thought of as a leading indicator and generally leads the economy by 6 to 9 months. To keep pace with the market, it makes sense to look directly at the price movements. More often than not, change is a subtle beast. Even though the market is prone to sudden knee-jerk reactions, hints usually develop before significant moves. A technician will refer to periods of accumulation as evidence of an impending advance and periods of distribution as evidence of an impending decline.

Supply, Demand, and Price Action

Many technicians use the open, high, low and close when analyzing the price action of a security. There is information to be gleaned from each bit of information. Separately, these will not be able to tell much. However, taken together, the open, high, low and close reflect forces of supply and demand.

The annotated example above shows a stock that opened with a gap up. Before the open, the number of buy orders exceeded the number of sell orders and the price was raised to attract more sellers. Demand was brisk from the start. The intraday high reflects the strength of demand (buyers). The intraday low reflects the availability of supply (sellers). The close represents the final price agreed upon by the buyers and the sellers. In this case, the close is well below the high and much closer to the low. This tells us that even though demand (buyers) was strong during the day, supply (sellers) ultimately prevailed and forced the price back down. Even after this selling pressure, the close remained above the open. By looking at price action over an extended period of time, we can see the battle between supply and demand unfold. In its most basic form, higher prices reflect increased demand and lower prices reflect increased supply.

Support/Resistance

Simple chart analysis can help identify support and resistance levels. These are usually marked by periods of congestion (trading range) where the prices move within a confined range for an extended period, telling us that the forces of supply and demand are deadlocked. When prices move out of the trading range, it signals that either supply or demand has started to get the upper hand. If prices move above the upper band of the trading range, then demand is winning. If prices move below the lower band, then supply is winning.

Pictorial Price History

Even if you are a tried and true fundamental analyst, a price chart can offer plenty of valuable information. The price chart is an easy to read historical account of a security's price movement over a period of time. Charts are much easier to read than a table of numbers. On most stock charts, volume bars are displayed at the bottom. With this historical picture, it is easy to identify the following:

• Reactions prior to and after important events.
• Past and present volatility.
• Historical volume or trading levels.
• Relative strength of a stock versus the overall market.

Assist with Entry Point

Technical analysis can help with timing a proper entry point. Some analysts use fundamental analysis to decide what to buy and technical analysis to decide when to buy. It is no secret that timing can play an important role in performance. Technical analysis can help spot demand (support) and supply (resistance) levels as well as breakouts. Simply waiting for a breakout above resistance or buying near support levels can improve returns.
It is also important to know a stock's price history. If a stock you thought was great for the last 2 years has traded flat for those two years, it would appear that Wall Street has a different opinion. If a stock has already advanced significantly, it may be prudent to wait for a pullback. Or, if the stock is trending lower, it might pay to wait for buying interest and a trend reversal.

Weaknesses of Technical Analysis

Analyst Bias

Just as with fundamental analysis, technical analysis is subjective and our personal biases can be reflected in the analysis. It is important to be aware of these biases when analyzing a chart. If the analyst is a perpetual bull, then a bullish bias will overshadow the analysis. On the other hand, if the analyst is a disgruntled eternal bear, then the analysis will probably have a bearish tilt.

Open to Interpretation

Furthering the bias argument is the fact that technical analysis is open to interpretation. Even though there are standards, many times two technicians will look at the same chart and paint two different scenarios or see different patterns. Both will be able to come up with logical support and resistance levels as well as key breaks to justify their position. While this can be frustrating, it should be pointed out that technical analysis is more like an art than a science, somewhat like economics. Is the cup half-empty or half-full? It is in the eye of the beholder.

Too Late

Technical analysis has been criticized for being too late. By the time the trend is identified, a substantial portion of the move has already taken place. After such a large move, the reward to risk ratio is not great. Lateness is a particular criticism of Dow Theory.

Always Another Level

Even after a new trend has been identified, there is always another "important" level close at hand. Technicians have been accused of sitting on the fence and never taking an unqualified stance. Even if they are bullish, there is always some indicator or some level that will qualify their opinion.

Trader's Remorse

Not all technical signals and patterns work. When you begin to study technical analysis, you will come across an array of patterns and indicators with rules to match. For instance: A sell signal is given when the neckline of a head and shoulders pattern is broken. Even though this is a rule, it is not steadfast and can be subject to other factors such as volume and momentum. In that same vein, what works for one particular stock may not work for another. A 50-day moving average may work great to identify support and resistance for IBM, but a 70-day moving average may work better for Yahoo. Even though many principles of technical analysis are universal, each security will have its own idiosyncrasies.

Conclusions

Technical analysts consider the market to be 80% psychological and 20% logical. Fundamental analysts consider the market to be 20% psychological and 80% logical. Psychological or logical may be open for debate, but there is no questioning the current price of a security. After all, it is available for all to see and nobody doubts its legitimacy. The price set by the market reflects the sum knowledge of all participants, and we are not dealing with lightweights here. These participants have considered (discounted) everything under the sun and settled on a price to buy or sell. These are the forces of supply and demand at work. By examining price action to determine which force is prevailing, technical analysis focuses directly on the bottom line: What is the price? Where has it been? Where is it going?
Even though there are some universal principles and rules that can be applied, it must be remembered that technical analysis is more an art form than a science. As an art form, it is subject to interpretation. However, it is also flexible in its approach and each investor should use only that which suits his or her style. Developing a style takes time, effort and dedication, but the rewards can be significant.

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