Trading and investing are two different beasts, but how you go about researching each trading strategy is the same in most cases.
The two methodologies you can utilize when reviewing a stock are technical analysis and fundamental analysis.
Each with their own benefits and draw downs, provide you with insight into different aspects of the market. Not to say one is better than the other, but rather that when used correctly each will provide you with different market insights the other may not.
This article will dive into each of the two methodologies and describe what each entails.
How to Analyze a Stock for Beginners
Let us begin with an overview of fundamental analysis. Fundamental analysis is when you take a company you are looking to invest in and begin reviewing their fundamental data.
This includes financials, executive compensation, company direction, and the overall health of the company.
Using this analysis is great for those who are looking to invest long term in a company and need to understand if the business is sustainable long term.
One of the drawbacks to fundamental analysis is it ignores the trading chart.
When you look at the fundamentals of an organization, it could be the healthiest company you’ve ever seen, but according to the chart the market may think otherwise and the stock could be down for the year.
That’s why it is important to utilize both methods when researching, but we’ll get into that later.
Let us dig deeper into understanding what to review when applying fundamental research.
For an example we’ll use Apple because that’s a company everyone knows and loves.
You would start by simply understanding their business model, which is electronics, entertainment, etc.
The importance of this is you’ll need something to compare numbers too and you can utilize the sector performance and other benchmarks.
From there, you can begin looking into the financials, which are easily found on many different websites such as Yahoo Finance or Seeking Alpha.
For Apple, you would want to look at the income statement and review the line items of sales/revenue, seeing how those numbers have progressed.
Moving down the income statement, you’ll want to review EBITDA.
You can then move to the balance sheet, which allows you to take a glimpse into total assets. This is more important in manufacturing and engineering companies, but not to be overlooked, no matter what company you are researching.
The balance also breaks down inventories, which for product selling companies should be a steady or decreasing number because inventory on a shelf means money that can’t be allocated elsewhere.
Lastly, you can move to the cash flow statement.
This is where you’ll decide if Apple for our example is doing well with cash flow.
Cash to a business is blood is to a human, it is necessary to keep cash moving. You’ll be able to review dividends, capital expenditures, and debt levels. If a company is too leveraged, it can mean a restriction on cash flows.
Once you’ve reviewed the financials, you can compare it against its peers by completing the same process, ideally with companies in the same market sector.
The overarching goal with the research is first, understand if the market is pricing the stock accurately.
Secondly, to understand how the company is doing compared to direct competitors.
You wouldn’t purchase Apple if Samsung is trading at a discount compared to Apple at a premium.
The second methodology that works well in analyzing a stock is technical analysis.
With technical analysis, you are not analyzing the fundamental information but rather the chart and data present in the chart.
There are many different ways to technically analyze a stock chart but we’ll go over some of the most common.
First is how you want the chart to be presented. Many people utilize the candlestick chart, which plots the open, high, low, and close for your specified trading range.
Utilizing this charting style allows you to visually see where the stock price is going in terms of long-term trends, etc.
Now, once you’ve decided on your chart style it’s time to understand how to analyze the chart.
Many traders utilize the Moving Average, which is typically plotted as a 20-day moving average. With longer term investing, you can utilize the 50-day and 200-day Moving Averages as well. This can be used in forming support and resistance levels within a chart.
An example of market shift would be the 50-day moving average crossing the 200-day moving average in either direction.
Volume is another data point that is used when technically analyzing a stock.
Understanding how volume works is critical because it can help you understand where the market may go.
For example, if Apple has a large down day but the volume was low compared to the average daily volume, this could be a move that many traders didn’t participate in and potentially being an unsupported move. Likewise for the reverse, as a high move upward on low volume could be a false break to the upside.
Lastly, many traders will utilize Bollinger Bands, which plot support and resistance channels based upon price action.
With technical analysis, traders are simply looking at where the market has been and where it might want to go, simply based on volume and price action.
Now that you have an understanding of both technical and fundamental analysis, the idea is to combine them to formulate the best strategy to fit your needs.
For example, once you’ve analyzed Apple’s cash flows and income statements, you can compare to where the market is currently trading.
The overall goal is to find value in these stocks and exploit it for your gain.
Warren Buffet does this and it’s called value investing, which is when you find a company that is trading at a deep discount but has really healthy financials.
One method isn’t better than the other, rather one offers you a different perspective the other cannot. Combined, you can begin to put together a game plan to fit your trading or investing objectives.
Got a stock you think will be a big hit? Comment below!
My name is Nathan Young. With many years of experience in the financial sector and financial copywriting, I bring a unique view of the market. My specialties include personal finance, investing, and business writing. When I’m not writing I enjoy studying other market opinions, outdoor activities, and a proper Old Fashioned.