Analysis in trading

Analysis stands for a detailed examination of anything complex in order to understand its nature or to determine its essential features.

In trading, analysis is a trading discipline employed to evaluate investments and identify trading opportunities in price trends.

In simple words analysis is a process in which investment opportunity (buying or selling level) is find out  by using different tools and collecting data.

Successful investors use deep analysis to pick stocks and make intelligent investment decisions. It enables an investor to prepare for the share market in advance and purchase stocks which can prove profitable when sold in the future.

 As a trader analyzing financial markets, it is important to have a solid approach to making trading decisions with suitable sufficient reasons and placing trades to build a solid strategy. There are three types of market analysis–

• Technical Analysis
• Fundamental Analysis,
• Sentiment Analysis

Which can help you construct a stronger trading strategy.

Technical Analysis

Technical analysis is a method of evaluating markets by studying past data, mainly price and volume. Technical analysts believe that by looking at historical price data, it is based purely on the price charts of an asset. In this analysis patterns are identified that will help them predict future market behavior. It is a means of examining and predicting price movements in the financial markets, by using historical price charts and market statistics.

Pros and cons of technical analysis

Pros of technical analysis

Being able to identify the signals for price trends in a market is a key component of any trading strategy. All traders need to work out a methodology for locating the best entry and exit points in a market, and using technical analysis tools is a very popular way of doing so.

In fact, technical analysis tools are so commonly used, that many believe they have created self-fulfilling trading rules: As more and more traders use the same indicators to find support and resistance levels, there will be more buyers and sellers congregated around the same price points, and the patterns will inevitably be repeated.

Cons of technical analysis

There will always be an element of market behavior that is unpredictable. There is no definitive guarantee that any form of analysis – technical or fundamental – will be 100% accurate. Although historical price patterns give us an insight into an asset’s likely price trajectory, that is no promise of success.

Traders should use a range of indicators and analysis tools to get the highest level of assurance possible, and have a risk management strategy in place to protect against adverse movements.

Fundamental Analysis

 Fundamental analysis is another  method of evaluating the intrinsic value of an asset by analyzing the factors that could influence its price in the future. This form of analysis is based on external events and influences, as well as financial statements and industry trends.

In other words we can say It is a technique that is used to evaluate a market by looking at the underlying economic and financial factors that might impact that market. This type of analysis can be used to make trading decisions as well as to determine the fair value of a currency. fundamental analysis is one of the most popular methods among traders.

Fundamental analysis is usually done from a macro to micro perspective to identify securities that are not correctly priced by the market.

Fundamental analysts study anything that can affect the security’s value, from macroeconomic factors such as the state of the economy and industry conditions to microeconomics factors like the effectiveness of the company’s management.

Sources for Fundamental Analysis

Fundamental analysis uses publicly available financial data to evaluate the value of an investment. The data is recorded on financial statements such as quarterly and annual reports and filings like the 10-Q (quarterly) or 10-K (annual). The 8-K is also informative because public companies must file it any time a reportable event occurs, like an acquisition or upper-level management change.

For example, you might perform a fundamental analysis of a bond’s value by looking at economic factors such as interest rates and the overall state of the economy. Then, you’d evaluate the bond market and use financial data from similar bond issuers. Finally, you’d analyze the financial data from the issuing company, including external factors such as potential changes in its credit rating. You could also read through the 8-K, 10-Q, 10-K, and the issuer’s annual reports to find out what they are doing, their goals, or other issues.

Fundamental analysis uses a company’s revenues, earnings, future growth, return on equity, profit margins, and other data to determine a company’s underlying value and potential for future growth.

The various fundamental factors can be grouped into two categories: quantitative and qualitative. The financial meaning of these terms isn’t much different from well-known definitions:

• Quantitative: information that can be shown using numbers, figures, ratios, or formulas
• Qualitative: rather than a quantity of something, it is its quality, standard, or nature

In this context, quantitative fundamentals are hard numbers. They are the measurable characteristics of a business. That’s why the biggest source of quantitative data is financial statements. Revenue, profit, assets, and more can be accurately measured.

The qualitative fundamentals are less tangible. They might include the quality of a company’s key executives, brand-name recognition, patents, and proprietary technology.

Neither qualitative nor quantitative analysis is inherently better. Many analysts consider them together.

Qualitative Fundamentals to Consider

There are four key fundamentals that analysts always consider when regarding a company. All are qualitative rather than quantitative. They include:

The Business Model

What exactly does the company do? This isn’t as straightforward as it seems. If a company’s business model is based on selling fast-food chicken, is it making its money that way? Or is it just coasting on royalty and franchise fees?

Competitive Advantage

A company’s long-term success is primarily driven by its ability to maintain a competitive advantage—and keep it. Powerful competitive advantages, such as Coca-Cola’s brand name and Microsoft’s domination of the personal computer operating system, create a moat around a business allowing it to keep competitors at bay and enjoy growth and profits. When a company can achieve a competitive advantage, its shareholders can be well rewarded for decades.

Management

Some believe management is the most important criterion for investing in a company. It makes sense: Even the best business model is doomed if the company’s leaders fail to execute the plan properly. While it’s hard for retail investors to meet and truly evaluate managers, you can look at the corporate website and check the resumes of the top brass and the board members. How well did they perform in previous jobs? Have they been unloading a lot of their stock shares lately?

Corporate Governance

Corporate governance describes the policies in place within an organization denoting the relationships and responsibilities between management, directors, and stakeholders. These policies are defined and determined in the company charter, its bylaws, and corporate laws and regulations. You want to do business with a company that is run ethically, fairly, transparently, and efficiently. Particularly note whether management respects shareholder rights and shareholder interests. Make sure their communications to shareholders are transparent, clear, and understandable. If you don’t get it, it’s probably because they don’t want you to.

Industry

It’s also important to consider a company’s industry: its customer base, market share among firms, industry-wide growth, competition, regulation, and business cycles. Learning how the industry works will give an investor a deeper understanding of a company’s financial health.

Quantitative Fundamentals to Consider: Financial Statements

Financial statements are the medium by which a company discloses information concerning its financial performance. Followers of fundamental analysis use quantitative information from financial statements to make investment decisions. The three most important financial statements are income statements, balance sheets, and cash flow statements.

The Balance Sheet

The balance sheet represents a record of a company’s assets, liabilities, and equity at a particular point in time. It is called a balance sheet because the three sections—assets, liabilities, and shareholders’ equity—must balance using the formula:

Assets = Liabilities + Shareholders’ Equity

Assets represent the resources the business owns or controls at a given time. This includes items such as cash, inventory, machinery, and buildings. The other side of the equation represents the total financing value the company has used to acquire those assets.

Financing comes as a result of liabilities or equity. Liabilities represent debts or obligations that must be paid. In contrast, equity represents the total value of money that the owners have contributed to the business—including retained earnings, which is the profit left after paying all current obligations, dividends, and taxes.

The Income Statement

While the balance sheet takes a snapshot approach in examining a business, the income statement measures a company’s performance over a specific time frame. Technically, you could have a balance sheet for a month or even a day, but you’ll only see public companies report quarterly and annually.

The income statement presents revenues, expenses, and profit generated from the business’ operations for that period.

Statement of Cash Flows

The statement of cash flows represents a record of a business’ cash inflows and outflows over a period of time. Typically, a statement of cash flows focuses on the following cash-related activities:

• Cash from investing (CFI): Cash used for investing in assets, as well as the proceeds from the sale of other businesses, equipment, or long-term assets
• Cash from financing (CFF): Cash paid or received from the issuing and borrowing of funds
• Operating Cash Flow (OCF): Cash generated from day-to-day business operations

The cash flow statement is important because it’s challenging for a business to manipulate its cash situation. There is plenty that aggressive accountants can do to manipulate earnings, but it’s tough to fake cash in the bank. For this reason, some investors use the cash flow statement as a more conservative measure of a company’s performance.

Fundamental analysis relies on using financial ratios drawn from data on corporate financial statements to make inferences about a company’s value and prospects.

Example of Fundamental Analysis

The Coca-Cola Company is a prime example that can be used in fundamental analysis. To begin, an analyst would examine the economy using some published metrics:

• Consumer price index (inflation measure)
• Gross domestic product growth
• Exports/imports
• Purchasing manager’s index
• Interest rates

Then, the sector and industry would be examined using statistics and metrics from various reports and competitor companies. Lastly, the analysts would gather the reports from Coca-Cola or the Security and Exchange Commission’s Edgar filings database.1

Securities and Exchange Commission. “EDGAR | Company Filings.”

Analysts might also use data gathered by another firm, such as CSIMarket. CSIMarket provides fundamental analysis data for investors, so you could begin by assessing the value of Coca-Cola’s assets, income streams, debts, and liabilities. You might find comparisons of objective metrics such as revenue, profits, and growth, especially in the context of the broader beverage industry.

Using CSIMarket’s analysis, the analyst could compare growth rates to the industry and sector Coca-Cola operates in, along with the other information provided, to see if the company is valued correctly. For example, as of August 2022, for the trailing twelve months (TTM), Coca-Cola had (using only a few of the possible ratios and metrics):2

One factor not shown in an analysis of ratios and numbers is how long a company has been around and the conditions they have weathered. Coca-Cola was founded in 1892 in Atlanta, Georgia.3 It has stayed in business through several wars, depressions, recessions, epidemics, pandemics, stock market crashes, and a global financial crisis. Not many companies can claim a history like that.

Additionally, a company’s brand can add value to an investment. Coca-Cola has been providing beverages for a long time, and its logo is recognized worldwide.

So, an analyst can combine brand, longevity, growth above that of the beverages manufacturing industry, an above average price-to-earnings ratio, and good return on investment.

Coca-Cola has more debt than equity, but it also generates more returns using its assets than the rest of the industry. The company doesn’t have as much liquidity as other companies, but it seems the industry hovers on pretty low quick ratios. More than 1.0 means a company can pay its short-term obligations quickly—so in general, most of the industry is low, but Coca-Cola has more than $1 billion in net cash flows, which gives it a lot of wriggle room.4

An interesting measurement is how much revenue one employee generates. Coca-Cola employees generate about twice as much revenue as employees for comparative companies. This might warrant a deeper investigation into what Coca-Cola is doing differently. They may have invested in new technology or have much more efficient systems. Looking over press releases and reading company reports can provide insights into what the company is doing. It might also be that Coca-Cola simply sells more products than its competitors, so it’s important to review any reports and releases and conduct a fundamental analysis carefully.

Sentiment Analysis

Sentiment analysis is a way of gauging how people feel about something. It can be applied to any type of content or data, including social media, reviews, articles etc., and it can be used to understand the general feeling around a certain topic. It is a branch of data science that analyses people’s emotions, opinions, and attitudes. This can be used to discover how a group feels about certain topics.

As a market trader, it is essential to understand what sentiment analysis is and how it can be used to your advantage.

By analysing markets and trader sentiment, you can forecast future market trends (remember that no forecast is 100% accurate) and make more informed decisions about where and when to place trades.

Forex market sentiment indicates the general attitude of traders toward a particular currency (say, the US Dollar) or a currency pair (such as EUR/GBP). It is the crowd psychology of a currency market, its tone or feeling, as shown through the activity and price movement of the forex pair.