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How to Analyse Stocks: Fundamental and Technical Analysis

Stock analysis is the process of evaluating the potential value of securities based on various factors. For investors, this is one of the most crucial steps in decision-making, as proper analysis allows for minimising risks and increasing returns. There are two main methods of stock analysis: fundamental analysis and technical analysis. Both approaches have their unique features and areas of application, and their combination provides more accurate predictions. In this article, we will examine each method in detail, their advantages and disadvantages, and offer practical recommendations for investors.

Why Analyze Stocks?

Investing in stocks always involves risks. Stock prices can fluctuate due to a variety of factors, from economic changes to internal company issues. Without thorough analysis, an investor may lose money by investing in unprofitable or undervalued companies. Stock analysis helps to avoid such situations and answers key questions:
  • Is the company financially stable?
  • Does the current stock price reflect the actual value of the company?
  • What factors may influence the future returns of the stock?
An investor who knows how to analyse stocks can make more informed decisions, minimising risks and maximising profits.

Fundamental Analysis

Fundamental analysis is a method through which an investor attempts to assess a company's intrinsic value based on its financial health, market position, macroeconomic situation, and growth prospects. This analysis helps understand whether the current stock price is justified and if there are prospects for further growth.

Key Elements of Fundamental Analysis

Financial Statements

The company's financial statements are the primary source of information for an investor aiming to evaluate the current state of the business and its prospects. There are three main documents:
  • Balance Sheet. Provides information on what the company owns (assets) and what it owes (liabilities). It helps assess the company's financial stability and its ability to meet its obligations.
  • Income Statement. Demonstrates the company’s revenues and expenses over a certain period, as well as its net profit. It is a critical measure of profitability.
  • Cash Flow Statement. Shows how the company manages its cash flows. This document is particularly important for assessing liquidity and the company’s ability to sustain and grow its business.

Key Financial Ratios

  • Price-to-Earnings Ratio (P/E). Shows how many times the market price of a stock exceeds its earnings per share. The lower this ratio, the "cheaper" the company's stock is considered.
  • Return on Assets (ROA). Measures a company’s profitability in relation to its assets. The higher the ROA, the more efficiently the company uses its assets to generate profit.
  • Return on Equity (ROE). Indicates how effectively a company uses its shareholders’ equity to generate profits.

Macroeconomic Analysis

External economic conditions play an important role in fundamental analysis. Investors need to consider factors like the state of the global economy, inflation, interest rates, and exchange rates. For example, if the economy is in recession, even the strongest companies may face difficulties.

Competitive Analysis

Assessing the company’s position in its industry and its competitive advantages is a key part of fundamental analysis. It’s important to understand:
  • What is the company’s market share?
  • What competitive advantages does it have (e.g., exclusive technologies, strong brand)?
  • How sustainable is its business model in the long run?

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How to Perform Fundamental Analysis

  1. Analyze Financial Statements. Start by studying the company's core financial documents. Evaluate its profits, debt levels, capital expenditures, and cash flow.
  2. Assess Competitive Position. Research the market in which the company operates, its main competitors, and market shares.
  3. Evaluate Future Growth. Forecasting the company's growth is a critical part of the analysis. This involves using the company’s historical earnings growth and current market conditions.
  4. Assess Company Leadership. Strong management is often a key factor in a company’s success. Research who leads the company, their experience, and past successful projects.
Fundamental stock market analysis focuses on a company’s long-term prospects, offering investors the opportunity to identify undervalued stocks and invest for years to come.

Technical Analysis

Technical analysis is an approach in which investors attempt to predict future stock price movements based on their past performance and trading volume. This method is based on the assumption that the market factors in all necessary information, and the stock price reflects all available data.

Key Tools of Technical Analysis

Price Charts

Technical analysts use various types of charts to visualise stock price movements. The most popular include:
  • Candlestick Charts. Each candlestick shows the price movement over a specific period, including opening, closing, high, and low prices.
  • Line Charts. These display only the stock’s closing price for each time interval.
  • Bar Charts. These show not only the closing price but also the trading volume for a specific period.

Trend Indicators

  • Moving Averages. One of the most popular indicators for identifying trends. Moving averages smooth out price fluctuations, helping to reveal overall market directions.
  • Bollinger Bands. This indicator helps determine market volatility and potential trend reversal points.

Oscillators

  • RSI (Relative Strength Index). An index that shows whether a stock is overbought or oversold. RSI signals when a stock may be ready for a trend change.
  • MACD (Moving Average Convergence Divergence). An indicator that shows the divergence between two moving averages, which can signal an upcoming trend change.

Support and Resistance Levels

Support levels are price points below which a stock rarely falls, and resistance levels are points above which a stock rarely rises. These levels are crucial for determining optimal entry and exit points.

How to Conduct Technical Analysis

  1. Identify the Trend. The first step in technical analysis is identifying the current trend: upward, downward, or sideways.
  2. Use Trend Indicators. Applying indicators like moving averages helps accurately determine the trend direction.
  3. Evaluate Market Volatility. Tools like Bollinger Bands can be used to assess the amplitude of price fluctuations.
  4. Analyze Support and Resistance Levels. These levels help identify key points for opening and closing positions.
  5. Use Oscillators. RSI and MACD help determine when the market is overbought or oversold, signalling a potential trend reversal.

Comparison of Fundamental and Technical Analysis

Fundamental and technical analysis serve different purposes and are geared toward different types of investors.
  • Fundamental Analysis. Used by long-term investors who focus on a company's real value and financial performance. This method is suitable for those who prefer to invest for years and benefit from long-term growth.
  • Technical Analysis. Often used by short-term traders who seek to profit from price fluctuations over short periods. This method is better suited for active traders who monitor the market constantly.

Long-Term and Short-Term Strategies

Long-term strategies are based on fundamental analysis, where an investor buys stocks with the expectation of growth over several years. Short-term strategies involve active trading based on technical analysis. Traders may buy and sell stocks within a day or over a few days, profiting from small price fluctuations.

Conclusion

For successful investing, it is important to use both fundamental and technical analysis. Fundamental analysis helps select companies with long-term growth prospects, while technical analysis allows identifying the best moments for entering and exiting the market. Investors are encouraged to combine both approaches to achieve maximum results and minimise risks.
For beginner investors, it is important to start by mastering the basics of each method and then integrating them into their investment strategy.