Unit- 2

SECURITY ANALYSIS:

Introduction – Fundamental Analysis – Economic Analysis – Industry Analysis – Company

Analysis. Technical Analysis – Dow Theory – Advanced Declined Theory – Chartism
Assumptions of Technical Analysis.

Fundamental analysis:
Introduction:
Fundamental analysis is a method of evaluating a security in an attempt to measure
its intrinsic value, by examining related economic, financial and other qualitative and
quantitative factors. Fundamental analysts study anything that can affect the security's value,
including macroeconomic factors such as the overall economy and industry conditions, and
microeconomic factors such as financial conditions and company management. The end goal of
fundamental analysis is to produce a quantitative value that an investor can compare with a
security's current price, thus indicating whether the security is undervalued or overvalued.
Meaning:
Fundamental analysis typically refers to a method of analyzing and evaluating equities,
though it may also apply to any kind of security. A whole slew of data including, but not limited
to, financial statements, economics, health, management, interest rates, production, earnings,
competitive advantages, competitors and many other qualitative and quantitative factors are
considered.
Definition:
Fundamental Analysis is a method of evaluating a security by attempting to measure its intrinsic
value by examining related economic, financial and other qualitative and quantitative factors.
Fundamental analysts attempt to study everything that can affect the security’s value, including
macroeconomic factors (like the overall economy and industry conditions) and individual
specific factors (like the financial condition and management of companies).
OBJECTIVES OF FUNDAMENTAL ANALYSIS
 To predict the direction of national economy because economic activity affects the
corporate profit, investor attitudes and expectation and ultimately security prices.
 To estimate the stock price changes by studying the forces operating in the overall
economy, as well as influences peculiar to industries and companies.
 To select the right time and right securities for the investment
THREE PHASES OF FUNDAMENTAL ANALYSIS
• Understanding of the macro-economic environment and developments (Economic
Analysis)
• Analyzing the prospects of the industry to which the firm belongs (Industry Analysis)
• Assessing the projected performance of the company (Company Analysis)
The three phase examination of fundamental analysis is also called as an EIC (Economy-
Industry-Company analysis) framework or a top-down approach-
Here the financial analyst first makes forecasts for the economy, then for industries and finally
for companies. The industry forecasts are based on the forecasts for the economy and in turn, the
company forecasts are based on the forecasts for both the industry and the economy. Also in this
approach, industry groups are compared against other industry groups and companies against
other companies. Usually, companies are compared with others in the same group.
Thus, the fundamental analysis is a 3 phase analysis of
• The economy
 • The industry and
• The company

Phase Nature of Purpose Tools and techniques

Analysis

FIRST Economic To access the general Economic indicators

Analysis Economic situation of the
nation.

SECOND To assess the prospects of Industry life cycle analysis,

Industry Analysis various industry groupings. Competitive analysis of
industries etc.

THIRD To analyse the Financial and Analysis ofFinancial

Company Analysis Non-financial aspects of a aspects: Sales,
Company todetermine Profitability, EPS etc.
whether to buy, sell or hold Analysis of Non-financial
the shares of a company. aspects: management,
corporate image, product
quality etc.

STRENGTHS OF FUNDAMENTAL ANALYSIS


Long-term Trends
Fundamental analysis is good for long term investments based on long-term trends. The
ability to identify and predict long-term economic, demographic, technological or consumer
trends can benefit investors and helps in picking 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 for long-term and value. Fundamental analysis can help
uncover the 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. A good understanding
can help investors avoid companies that are prone to shortfalls and identify those that continue to
deliver.
Value Drivers
In addition to understanding the business, fundamental analysis allows investors to develop
an understanding of the key value drivers within the company. A stock’s price is heavily
influenced by the 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) etc.
Knowing Who is Who
 Stocks move as a group. Knowing a company’s business, investors can better categorize
stocks within their relevant industry group that can make a huge difference in relative valuations.
The primary motive of buying a share is to sell it subsequently at a higher price. In many cases,
dividends are also to be expected. Thus, dividends and price changes constitute the return from
investing in shares.
Consequently, an investor would be interested to know the dividend to be paid on the
share in the future as also the future price of the share. These values can only be estimated and
not predicted with certainty. These values are primarily determined by the performance of the
company which in turn is influenced by the performance of the industry to which the company
belongs and the general economic and socio-political scenario of the country.
Economic Analysis
A particular firm or company is a micro unit of the economy as a whole. Fluctuations in
security markets are related to changes in expectations for the aggregate economy. Prospects of
the firms are tied to those of the broader economy even that of international economy. For some
firms, macroeconomic and industry circumstances might have a greater influence on profits and
cash flows that the firm’s relative performance within its industry.
Commonly Analyzed Factors in Economic analysis:
Global Economy: The economic analysis should start from the global economy. Since the
economies are interrelated – thus the firms across economies, the international economy can
affect a firm’s prospects. It affects the price competition it faces from competitors, or the profits
it makes on investments abroad. At a particular point of time, there can be variations in the
economic performance across countries. Similarly, political risks can be of greater magnitude in
other countries compared to domestic political environment. Fluctuations in currency exchange
rate also affect the performance of companies. Figure 13.1 depicts the real GDP growth of
developed and emerging economies. One can see that trend is not always similar and the pattern
in rate of growth is also different. The emerging economies show higher growth in comparison to
developed economies. One need not be surprised about attraction of investors towards emerging
economies. If explored further, different countries in a particular group [emerging or developed]
would also show varied GDP growth and pattern.
Domestic Macro Economy: An analyst should be able to forecast about domestic macro
economy better than other analysts. By this, the analyst [for that matter, a fund manager] can
outsmart the peers in showing investment performance. The key macroeconomic variables that
an analyst should look at are:
• Gross Domestic Product: Measure of the economy’s total production of goods and
services. Growth in GDP reflects opportunities for a firm to increase its revenue by
selling more products or services.
• Industrial Growth Rate: Although part of GDP growth, industry growth rates indicates
the activity in manufacturing sector of the economy.
• Monsoon and Agriculture: For agrarian economies these two factors are
pertinent. Several industries also depend on agriculture for inputs. Level of
monsoon indicates the likely performance of agriculture sector.
• Employment and Capacity Utilization: The employment of labour as well as
other factors of production [like machine capacity] indicates the level of economic
activity in the country.
• Price Level and Inflation: The general level of price rise is known as inflation. When
demand for products and services are higher than the productive capacity, there can be
high inflation. The governments and monetary regulators like Reserve Bank of India try
to draw a balance between inflation, growth and unemployment.
 • Interest Rates: Sectors like consumer durables, automobiles and housing are highly
sensitive to interest rates. High interest rates also reduce the present value of
investment.

• Budget Deficit: This is the difference between government spending and revenues. The
shortfall is taken care by government borrowing. Government borrowing can impact
interest rates as well as restrict the private sector borrowings from market.
• Sentiment: Depending upon the level of confidence of consumers in future income
levels, they will like to spend more in future which in turn affects the confidence of
producers. Accordingly producers plan their investment activity.

Industry Analysis
Industry analysis is a tool that facilitates a company's understanding of its position
relative to other companies that produce similar products or services. Understanding the forces at
work in the overall industry is an important component of effective strategic planning. Industry
analysis enables small business owners to identify the threats and opportunities facing their
businesses, and to focus their resources on developing unique capabilities that could lead to a
competitive advantage.
Industry Factors & Trends
Describe factors and trends affecting your industry and consider their implications for your
business. Issues to think about include:
 Demographic - The basic characteristics that your customers tend to have in common, like
age, income level, geography or gender
 Social - Fads or shifts in popular opinion, often strongly influenced by the media, including
television shows and commercials, sports teams and icons, magazines and peer pressures
 Economic - The state of the economy, both on a local and national level.
 Technological - How technology is affecting your industry
 Regulatory - The role government or other rule-making bodies play in your industry.
 Environmental - Your industry's relationship with the environment. Consider trends, like a
call for environmentally-friendly products.

Commonly Analyzed Factors in Industry analysis:

Market Size
Imagine you have no competition, and your customers' only option is to buy your product or
service. How many customers would you have? How much money would your business make?
That's the size of your market.
Demand Shocks Supply Shocks
• Reduction in Tax rates • Natural calamity
• Increase in money supply • Changes in educational level of workforce
• Increases in government spending • Changes in the wage rates
• Changes in the price of imported oil
When estimating the size of your market, consider industry factors and trends, and pay special
attention to those you think present special opportunities or challenges for your business.
Government Policy: Governments and monetary authorities devise policies affecting both
demand and supply conditions in the economy.
Demand-side Policies are expected to stimulate the total demand for goods and services. The
two major demand-side policies are fiscal and monetary policies.
Fiscal policy denotes the spending and tax actions of the government and is part of demand-
side management. Government has to strike the delicate balance between political condition
and economic stability. Government may hesitate in curtailing the spending in social sector
because of electoral compulsion.
Increase in tax rates can decrease the disposable income of the consumers. But the increased
tax collection can facilitate greater spending by the government for the economy. Without
appropriate tax collection, the deficit will increase thus leading to borrowing by the
government.
Monetary policy intends to regulate the money supply to affect the macroeconomy. Primarily
the effect of monetary policy is seen in terms of change in interest rate.
Expansionary monetary policy lowers the interest rate and stimulates investment and
consumption demand in short run. But it can also lead to higher prices, thus inflation in long
run.
Fiscal policy is designed by the government while monetary policy is designed and
implemented by the monetary authority i.e. the central bank of the country.

In conclusion, it is imperative for the investors and analysts to devise models to forecast
the market and take investment decision or tweak the existing investments. In the second part
of the module on Economic Analysis, we shall discuss the tools for economic forecasting
focusing more on the business cycle, economic indicators, indices etc.

Company Analysis
Introduction to company analysis
Company analysis is a process carried out by investors to evaluate securities, collecting
info related to the company’s profile, products and services as well as profitability. It is also
referred as ‘fundamental analysis.’ A company analysis incorporates basic info about the
company, like the mission statement and apparition and the goals and values. During the process
of company analysis, an investor also considers the company’s history, focusing on events which
have contributed in shaping the company.
Also, a company analysis looks into the goods and services offered by the company. If
the company is involved in manufacturing activities, the analysis studies the products produced
by the company and also analyzes the demand and quality of these products. Conversely, if it is a
service business, the investor studies the services put forward.

Procedure:
It is essential for a company analysis to be comprehensive to obtain strategic insight.
Being a thorough evaluation of an organization, the company analysis provides insight to
rationalize processes and make revenue potentials better.
The process of conducting a company analysis involves the following steps:
 The primary step is to determine the type of analysis which would work best for your
company.
  Research well about the methods for analysis. In order to perform a company analysis, it is
important to understand the expected outcome for doing so.
 The analysis should provide answer about what is done right and wrong on the basis of a
thorough evaluation. It is, therefore, important6 to make the right choice for the analysis
methods.
 The next step involves implementing the selected method for conducting the financial
analysis. It is important for the analysis to include internal and external factors affecting the
business.
 As a next step, all the major findings should be supported by use of statistics.
 The final step involves reviewing the results. The weaknesses are then attempted to be
corrected. The company analysis is used in concluding issues and determining the possible
solutions. The company analysis is conducted to provide a picture of the company at a
specific time, thus providing the best way of enhancing a company, internally as well as
externally.
Commonly Analyzed Factors in Industry analysis:

1. Market share: The market share of the company helps to determine a company’s
relative position within the industry. If the market share is high, the company would
be able to meet the competition successfully. The size of the company should also be
considered while analyzing the market share, because the smaller companies may find
it difficult to survive in the future.
2. Growth of annual sales: Investor generally prefers to study the growth in sales
because the larger size companies may be able to withstand the business cycle rather
than the company of smaller size. The rapid growth keeps the investor in better
position as growth in sales is followed by growth in profit. The growth in sales of the
company is analyzed both in rupee terms and in physical terms.
3. Stability of annual sales: If a firm has stable sales revenue, other things being
remaining constant, will have more stable earnings. Wide variation in sales leads to
variation in capacity utilization, financial planning and dividends. This affects the
Company’s position and investor’s decision to invest.
4. Earnings: The earning of the company should also be analyzed along with the sales
level. The income of the company is generated through the operating (in service
industry like banks- interest on loans and investment) and non-operating income (ant
company, rentals from lease, dividends from securities). The investor should analyze
the sources of income properly. The investor should be well aware with the fact that
the earnings of the company may vary due to following reasons:
 Change in sales.
 Change in costs.
 Depreciation method adopted.
 Inventory accounting method.
 Wages, salaries and fringe benefits.
 Income tax and other taxes.
5. Capital Structure: Capital structure is combination of owned capital and debt
capital which enables to maximize the value of the firm. Under this, we determine
the proportion in which the capital should be raised from the different securities.
The capital structure decisions are related with the mutual proportion of the long
term sources of capital. The owned capital includes share capital

(i) Preference shares: Preference shares are those shares which have
preferential rights regarding the payment of dividend and repayment of
capital over the equity shareholders. At present many companies resort
preference shares.
(ii) Debt: It is an important source of finance as it has the specific benefit
of low cost of capital because interest is tax deductible. The leverage
effect of debt is highly advantageous to the equity shareholders. The
limits of debt depend upon the firm’s earning capacity and its fixed
assets.
6. Management: Just as an army needs a general to lead it to victory, a company
relies upon management to steer it towards financial success. Some believe that
management is the most important aspect for investing in a company. It makes
sense - even the best business model is doomed if the leaders of the company fail
to properly execute the plan.
7. Past Performance: Another good way to get a feel for management capability is
to check and see how executives have done at other companies in the past. You
can normally find biographies of top executives on company web sites. Identify
the companies they worked at in the past and do a search on those companies and
their performance.
8. Operating Efficiency: 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 and its bylaws, along with corporate laws and
 regulations. The purpose of corporate governance policies is to ensure that proper
checks and balances are in place, making it more difficult for anyone to conduct
unethical and illegal activities.

Good corporate governance is a situation in which a company complies with all of its
governance policies and applicable government regulations in order to look out for the interests
of the company's investors and other stakeholders.
Although, there are companies and organizations that attempt to quantitatively assess companies
on how well their corporate governance policies serve stakeholders, most of these reports are
quite expensive for the average investor to purchase.
Fortunately, corporate governance policies typically cover a few general areas: structure
of the board of directors, stakeholder rights and financial and information transparency. With a
little research and the right questions in mind, investors can get a good idea about a company's
corporate governance.

Financial and Information Transparency

This aspect of governance relates to the quality and timeliness of a company's financial
disclosures and operational happenings. Sufficient transparency implies that a company's
financial releases are written in a manner that stakeholders can follow what management is doing
and therefore have a clear understanding of the company's current financial situation.

Stakeholder Rights
This aspect of corporate governance examines the extent that a company's policies are benefiting
stakeholder interests, notably shareholder interests. Ultimately, as owners of the company,
shareholders should have some access to the board of directors if they have concerns or want
something addressed. Therefore companies with good governance give shareholders a certain
amount of ownership voting rights to call meetings to discuss pressing issues with the board.
Another relevant area for good governance, in terms of ownership rights, is whether or not a
company possesses large amounts of takeover defenses (such as the Macaroni Defense or the
Poison Pill) or other measures that make it difficult for changes in management, directors and
ownership to occur. (To read more on takeover strategies, see The Wacky World of M&As.)

Structure of the Board of Directors

The board of directors is composed of representatives from the company and representatives
from outside of the company. The combination of inside and outside directors attempts to
provide an independent assessment of management's performance, making sure that the interests
of shareholders are represented.
The key word when looking at the board of directors is independence. The board of directors is
responsible for protecting shareholder interests and ensuring that the upper management of the
company is doing the same. The board possesses the right to hire and fire members of the board
on behalf of the shareholders. A board filled with insiders will often not serve as objective critics
of management and will defend their actions as good and beneficial, regardless of the
circumstances.
Information on the board of directors of a publicly traded company (such as biographies of
individual board members and compensation-related info) can be found in the DEF 14A proxy
statement.
 We've now gone over the business model, management and corporate governance. These three
areas are all important to consider when analyzing any company. We will now move on to
looking at qualitative factors in the environment in which the company operates.

 Financial Performance:
1. Balance Sheet: The level, trends, and stability of earnings are powerful forces in the
determination of security prices. Balance sheet shows the assets, liabilities and owner’s
equity in a company. It is the analyst’s primary source of information on the financial
strength of a company. Accounting principles dictate the basis for assigning values to
assets. Liability values are set by contracts. When assets are reduced by liabilities, the
book value of share holder’s equity can be ascertained. The book value differs from
current value in the market place, since market value is dependent upon the earnings
power of assets and not their cost of values in the accounts.
2. Profit and Loss account: It is also called as income statement. It expresses the results of
financial operations during an accounting year i.e. with the help of this statement we can
find out how much profit or loss has taken place from the operation of the business
during a period of time. It also helps to ascertain how the changes in the owner’s interest
in a given period have taken place due to business operations. Last of all, for analyzing
the financial position of any company following factors need to be considered for
evaluating present situation and prospects of company.

COMPANY ANALYSIS: THE STUDY OF FINANCIALS STATEMENTS

The massive amount of numbers in a company's financial statements can be bewildering and
intimidating to many investors. On the other hand, if you know how to analyze them, the
financial statements are a gold mine of information.
Financial statements are the medium by which a company discloses information concerning its
financial performance.
Followers of fundamental analysis use the quantitative information gleaned from financial
statements to make investment decisions. Before we jump into the specifics of the three most
important financial statements – income statements, balance sheets and cash flow statements -
we will briefly introduce each financial statement's specific function, along with where they can
be found.
The main techniques of financial analysis are:
1. Comparative Financial Statements
2. Trend Analysis
3. Common Size Statement
4. Fund Flow Statement
5. Cash Flow Statement
6. Ratio Analysis
1. Comparative Financial Statements: Financial statements of two or more firms may be
compared for drawing inferences. This is known as inter-firm comparison. Similarly, there may
be inter-period comparison, i.e., comparison of the financial statements of the same firm over a
period of years known as trend analysis. This is also known as horizontal analysis, since each
 accounting variable for two or more years is analyzed horizontally. Inter-firm or inter-period
comparisons are very much facilitated by the preparation of comparative statements. In preparing
these statements, the items are placed in the rows and the firms of years are shown in the
columns. Such arrangement facilitates highlighting the difference and brings out the significance
of such differences.
2. The statement also provides for columns to indicate the change form one year to another in
absolute terms and also in percentage form. In calculating percentages, there is one difficulty,
namely, if the figure is negative, percentages cannot be calculated. Likewise, if the change is
from or to a zero balance in account, it is not possible to calculate the percentage.
Advantages
 These statements indicate trends in sales, cost of production, profits, etc., helping the analyst to
evaluate the performance, efficiency and financial condition of the undertaking. For example, if
the sales are increasing coupled with the same or better profit margins, it indicates healthy
growth.
 Comparative statements can also be used to compare the position of the firm with the average
performance of the industry or with other firms. Such a comparison facilitates the identification
or weaknesses and remedying the situation.
Disadvantages
3. Inter-firm comparison may be misleading if the firms are not of the same age and size, follow
different accounting policies in relation to depreciation, valuation of stock, etc., and do not cater
to the same market. Inter-period comparison will also be misleading if the period has witnessed
frequent changes in accounting policies.
4. Trend Analysis: For analyzing the trend of data shown in the financial statements it is necessary
to have statements for a number of years. This method involves the calculation of percentage
relationship that each statement item bears to the same item in the “bas year”. Trend percentages
disclose changes in the financial and operating data between specific periods and make possible
for the analyst to form an opinion as to whether favorable or unfavorable tendencies are reflected
by the data.
5. Common Size Statement:
Financial statements when read with absolute figures are not easily understandable, sometimes
they are even misleading. It is, therefore, necessary that figures reported in these statements,
should be converted into percentage to some common base. In profit and loss account sales
figure is assumed to be equal to 100 and all other figures are expressed as percentage of sales.
Similarly, in balance sheet the total of assets or liabilities is taken as 100 and all the figures are
expressed as percentage of the total. This type of analysis is called vertical analysis. This is a
static relationship because it is a study of relationship existing at a particular date. The statements
so prepared are called common-size statements
6. Fund Flow Statement: Income Statement or Profit or Loss Account helps in ascertainment of
profit or loss for a fixed period. Balance Sheet shows the financial position of business on a
particular date at the close of year. Income statement does not fully explain funds from
operations of business because various non-fund items are shown in Profit or Loss Account.
Balance Sheet shows only static financial position of business and financial changes occurred
during a year can’t be known from the financial statement of a particular date. Thus, Fund Flow
Statement is prepared to find out financial changes between two dates. It is a technique of
analyzing financial statements. With the help of this statement, the amount of change in the
funds of a business between two dates and reasons thereof can be ascertained. The investor could
 see clearly the amount of funds generated or lost in operations. These reveal the real picture of
the financial position of the company.
7. Cash Flow Statement: The cash flow statement shows how much cash comes in and goes out of
the company over the quarter or the year. At first glance, that sounds a lot like the income
statement in that it records financial performance over a specified period. But there is a big
difference between the two.
8. Ratio Analysis: Ratio is a relationship between two figures expressed mathematically. It is
quantitative relationship between two items for the purpose of comparison. Ratio analysis is a
technique of analyzing financial statements. It helps in estimating financial soundness or
weakness. Ratios present the relationships between items presented in profit and loss account and
balance sheet. It summaries the data for easy understanding, comparison and interpretation. The
ratios are divided in the following group:
Liquidity Ratios
Liquidity ratios provide information about a firm's ability to meet its short-term financial
obligations. They are of particular interest to those extending short-term credit to the firm. Two
frequently-used liquidity ratios are the current ratio (or working capital ratio) and the quick
ratio.
The current ratio is the ratio of current assets to current liabilities:

Short-term creditors prefer a high current ratio since it reduces their risk. Shareholders may
prefer a lower current ratio so that more of the firm's assets are working to grow the business.
Typical values for the current ratio vary by firm and industry. For example, firms in cyclical
industries may maintain a higher current ratio in order to remain solvent during downturns.
One drawback of the current ratio is that inventory may include many items that are difficult to
liquidate quickly and that have uncertain liquidation values. The quick ratio is an alternative
measure of liquidity that does not include inventory in the current assets. The quick ratio is
defined as follows:

The current assets used in the quick ratio are cash, accounts receivable, and notes receivable.
These assets essentially are current assets less inventory. The quick ratio often is referred to as
the acid test. Finally, the cash ratio is the most conservative liquidity ratio. It excludes all current
assets except the most liquid: cash and cash equivalents. The cash ratio is defined as follows:

The cash ratio is an indication of the firm's ability to pay off its current liabilities if for some
reason immediate payment were demanded.
Asset Turnover Ratios: Asset turnover ratios indicate of how efficiently the firm utilizes
its assets. They sometimes are referred to as efficiency ratios, asset utilization ratios, or
 asset management ratios. Two commonly used asset turnover ratios are receivables
turnover and inventory turnover.
Receivables turnover is an indication of how quickly the firm collects its accounts receivables
and is defined as follows:

The receivables turnover often is reported in terms of the number of days that credit sales remain
in accounts receivable before they are collected. This number is known as the collection period.
It is the accounts receivable balance divided by the average daily credit sales, calculated as
follows:

The collection period also can be written as:

Another major asset turnover ratio is inventory turnover. It is the cost of goods sold in a time
period divided by the average inventory level during that period:

The inventory turnover often is reported as the inventory period, which is the number of days
worth of inventory on hand, calculated by dividing the inventory by the average daily cost of
goods sold:

The inventory period also can be written as:

Other asset turnover ratios include fixed asset turnover and total asset turnover.

Profitability ratios

Profitability ratios offer several different measures of the success of the firm at generating
profits.

The gross profit margin is a measure of the gross profit earned on sales. The gross profit margin
considers the firm's cost of goods sold, but does not include other costs. It is defined as follows:

Return on assets is a measure of how effectively the firm's assets are being used to generate
profits. It is defined as:

Return on equity is the bottom line measure for the shareholders, measuring the profits earned
for each dollar invested in the firm's stock. Return on equity is defined as follows:

FORECASTING EARNINGS
There is strong evidence that earnings have a direct and powerful effect upon dividends and share
prices. So the importance of forecasting earnings cannot be overstated. These ratios are generally
known as ‘Return on Investment Ratios’. These ratio help in evaluating whether the business is earning
adequate return on the capital invested or not. With the help of the following ratios the performance of
the business can be measured. The earnings forecasting ratios are:

 Return on Total Assets: A ratio that measures a company's earnings before interest and
taxes (EBIT) against its total net assets. The ratio is considered an indicator of how
effectively a company is using its assets to generate earnings before contractual obligations
must be paid.

To calculate ROTA:
Where EBIT = Net Income + Interest Expense + taxes
 The greater a company's earnings in proportion to its assets (and the greater the coefficient
from this calculation), the more effectively that company is said to be using its assets.
To calculate ROTA, you must obtain the net income figure from a company's income
statement, and then add back interest and/or taxes that were paid during the year. The
resulting number will reveal the company's EBIT. The EBIT number should then be divided
by the company's total net assets
 Return on Equity: The amount of net income returned as a percentage of shareholders
equity. Return on equity measures a corporation's profitability by revealing how much profit
a company generates with the money shareholders have invested.
ROE is expressed as a percentage and calculated as:
Return on Equity = Net Income/Shareholder's Equity
Net income is for the full fiscal year (before dividends paid to common stock holders but after
dividends to preferred stock.) Shareholder's equity does not include preferred shares.
Also known as "return on net worth" (RONW). The ROE is useful for comparing the
profitability of a company to that of other firms in the same industry.
There are several variations on the formula that investors may use:
1. Investors wishing to see the return on common equity may modify the formula above by
subtracting preferred dividends from net income and subtracting preferred equity from
shareholders' equity, giving the following: return on common equity (ROCE) = net income
- preferred dividends / common equity.
2. Return on equity may also be calculated by dividing net income by average shareholders'
equity. Average shareholders' equity is calculated by adding the shareholders' equity at the
beginning of a period to the shareholders' equity at period's end and dividing the result by
two.
3. Investors may also calculate the change in ROE for a period by first using the
shareholders' equity figure from the beginning of a period as a denominator to determine
the beginning ROE. Then, the end-of-period shareholders' equity can be used as the
denominator to determine the ending ROE. Calculating both beginning and ending ROEs
allows an investor to determine the change in profitability over the period.

TECHNICAL ANALYSIS

Fundamental analysis and Technical analysis are the two main approaches to security
analysis. Technical analysis is frequently used as a supplement to fundamental analysis rather
than as a substitute to it. According to technical analysis, the price of stock depends on demand
and supply in the market place. It has little correlation with the intrinsic value. All financial data
and market information of a given stock is already reflected in its market price.
Technical analysts have developed tools and techniques to study past patterns and predict
future price. Technical analysis is basically the study of the markets only. Technical analysts
study the technical characteristics which may be expected at market turning points and their
objective assessment. The previous turning points are studied with a view to develop some
characteristics that would help in identification of major market tops and bottoms. Human
reactions are, by and large consistent in similar though not identical reaction; with his various
tools, the technician attempts to correctly catch changes in trend and take advantage of them.
Technical analysis is directed towards predicting the price of a security. The price at
which a buyer and seller settle a deal is considered to be the one precise figure which
synthesis, weighs and finally expresses all factors, rational and irrational, quantifiable and
non-quantifiable and is the only figure that counts.

Thus, the technical analysis provides a simplified and comprehensive picture of what is
happening to the price of a security. Like a shadow or reflection it shows the broad outline of the
whole situation and it actually works in practice.

ASSUMPTIONS OF TECHNICAL ANALYSIS

 The market value of a security is solely determined by the interaction of demand and supply
factors operating in the market.
 The demand and supply factors of a security are surrounded by numerous factors; these
factors are both rational as well as irrational.
 The security prices move in trends or waves which can be both upward or downward
depending upon the sentiments, psychology and emotions of operators or traders.
 The present trends are influenced by the past trends and the projection of future trends is
possible by an analysis of past price trends.
 Except minor variations, stock prices tend to move in trends which continue to persist for an
appreciable length of time.
 Changes in trends in stock prices are caused whenever there is a shift in the demand and
supply factors.
 Shifts in demand and supply, no matter when and why they occur, can be detected through
charts prepared specially to show market action.
 Some chart trends tend to repeat themselves. Patterns which are projected by charts record
price movements and these patterns are used by technical analysis for making forecasts about
the future patterns.

TOOLS AND TECHNIQUES OF TECHNICAL ANALYSIS

There are numerous tools and techniques for doing technical analysis. Basically this analysis is
done from the following four important points of view:-
1) Prices: Whenever there is change in prices of securities, it is reflected in the changes in
investor attitude and demand and supply of securities.
2) Time: The degree of movement in price is a function of time. The longer it takes for a
reversal in trend, greater will be the price change that follows.
3) Volume: The intensity of price changes is reflected in the volume of transactions that
accompany the change. If an increase in price is accompanied by a small change in
transactions, it implies that the change is not strong enough.
4) Width: The quality of price change is measured by determining whether a change in
trend spreads across most sectors and industries or is concentrated in few securities only.
Study of the width of the market indicates the extent to which price changes have taken
place in the market in accordance with a certain overall trends.
 DOW THEORY
The Dow Theory, originally proposed by Charles Dow in 1900 is one of the oldest technical
methods still widely followed. The basic principles of technical analysis originate from this
theory.
According to Charles Dow “The market is always considered as having three movements, all
going at the same time. The first is the narrow movement from day to day. The second is the
short swing, running from two weeks to a month or more and the third is the main movement,
covering at least four years in its duration”.
The Theory advocates that stock behaviour is 90% psychological and 10% logical. It is the mood
of the Crowd which determines the way in which prices move and the move can be gauged by
analysing the price and volume of transactions.
The Dow Theory only describes the direction of market trends and does not attempt to forecast
future movements or estimate either the duration or the size of such market trends. The theory
uses the behaviour of the stock market as a barometer of business conditions rather than as a
basis for forecasting stock prices themselves. It is assumed that most of the stocks follow the
underlying market trend, most of the times.

A trend should be assumed to continue in effect until such time as its reversal has been
definitely signalled. The end of a bull market is signalled when a secondary reaction of decline
carries prices lower than the level recorded during the earlier reaction and the subsequent
advance fails to carry prices above the top level of the preceding recovery. The end of a bear
market is signalled when an intermediate recovery carries prices to a level higher than the one
registered in the previous advance and the subsequent decline halts above the level recorded in
the earlier reaction.
CHARTING
Charting is the basic tool in technical analysis, which provides visual assistance in
defecting changing pattern of price behaviour. The technical analyst is sometimes called the
Chartist because of importance of this tool. The Chartists believe that stock prices move in fairly
persistent trends. There is an inbuilt inertia, the price movement continues along a certain path
(up, down or sideways) until it meets an opposing force due to demand-supply changes. Chartists
also believe that generally volume and trend go hand in hand. When a major ‘up’ trend begins,
the volume of trading increases and the price and vice-versa.

The essence of Chartism is the belief that share prices trace out patterns over time. These are
a reflection of investor behaviour and it can be assumed that history tends to repeat itself in the
stock market. A certain pattern of activity that in the past produced certain results is likely to
give rise to the same outcome should it reappear in the future. The various types of commonly
used charts are:
a) Line Chart
b) Bar Chart
c) Point and figure Chart
Line Charts: The simplest form of chart is a line chart. Line charts are simple graphs drawn by
plotting the closing price of the stock on a given day and connecting the points thus plotted over
a period of time. Line charts take no notice of the highs and lows of stock prices for each period.
Bar Charts: It is a simple charting technique. In this chart, prices are indicated on the vertical
axis and the time on horizontal axis. The market or price movement for a given session (usually a
day) is represented on one line. The vertical part of the line shows the high and low prices at
which the stock traded or the market moved. A short horizontal tick on the vertical line indicates
the price or level at which the stock or market closed.
Point and Figure Chart (PFC): Though the point and figure chart is not as commonly used as
the other two charts, it differs from the others in concept and construction. In PFC there is no
time scale and only price movements are plotted. As a share price rises, a vertical column of
crosses is plotted.

When it falls, a circle is plotted in the next column and this is continued downward while the
price continues to fall. When it rises again, a new vertical line of crosses is plotted in the next
column and so on. A point and figure chart that changes column on every price reversal is
cumbersome and many show a reversal only for price changes of three units or more (a unit of
plot may be a price change of say one rupee).
MOVING AVERAGE ANALYSIS

The statistical method of moving averages is also used by technical analysts for forecasting the
prices of shares. While trends in share prices can be studied for possible patterns, sometimes it
may so happen that the prices appear to move rather haphazardly and be very volatile. Moving
average analysis can help under such circumstances.
A moving average is a smoothed presentation of underlying historical data. It is a summary
measure of price movement which reduces the distortions to a minimum by evening out the
fluctuations in share prices. The underlying trend in prices is clearly disclosed when moving
averages are used.
To construct a moving average the time span of the average has to be determined. A 10 day
moving average measures the average over the previous 10 trading days, a 20 day moving
average measures the average values over the previous 20 days and so on. Regardless of the time
period used, each day a new observation is included in the calculation and the oldest is dropped,
so a constant number of points are always being averaged.
RELATIVE STRENGTH
The empirical evidence shows that certain securities perform better than other securities in a
given market environment and this behaviour remains constant over time. Relative strength is
the technical name given to such securities by the technical analysts because these securities
have stability and are able to withstand both depression and peak periods. Investors should
invest in such securities, because these have constant strength in the market. The relative strength
analysis may be applied to individual securities or to whole industries or portfolios consisting of
stock and bonds. The relative strength can be calculated by:
i. Measuring the rate of return of securities
ii. Classifying securities
iii. Finding out the high average return of securities
iv. Using the technique of ratio analysis to find out the strength of an individual security.
Technical analysts measure relative strength as an indication for finding out the return of
securities. They have observed that those securities displaying greatest relative strength in good
markets (bull) also show the greatest weakness in bad markets (bear). These securities will rise
and fall faster than the market.
Technical analysts explain relative strength as a relationship between risk and return of a security
following the trends in the economy. After preparing charts from different securities over a
length of time, the technician would select certain securities which showed relative strength to be
the most promising investment opportunities.

RESISTANCE AND SUPPORT LEVELS

The peak price of the stock is called the resistance area. Resistance level is the price level to
which the stock or market rises and then falls repeatedly. This occurs during an uptrend or a
sideway trend. It is a price level to which the market advances repeatedly but cannot break
through. At this level, selling increases which causes the price fall.
Support level shows the previous low price of the stock. It is a price level to which a stock or
market price falls or bottom out repeatedly and then bounce up again.
Demand for the stock increases as the price approaches a support level. The buying pressure or
the demand supports the price of stock preventing it from going lower

Fundamental vs. Technical Analysis

Investors use techniques of fundamental analysis or technical analysis (or often
both) to make stock trading decisions. Fundamental analysis attempts to calculate the
intrinsic value of a stock using data such as revenue, expenses, growth prospects and the
competitive landscape, while technical analysis uses past market activity and stock price
trends to predict activity in the future.

Advanced Declined Theory:

The Advance - Decline Index Line or AD Line is an indicator used in the technical analysis of
the stock markets. The Advance - Decline Index line belongs to the family of market breadth
indicators which are used to measure the market volatility by focusing on how the stocks at an
exchange are behaving.

The Advance - Decline line measures the net stock advances which are derived from the number
of advancing stocks less the number of declining stocks. Needless to say, net advances rise when
there are more advancing stocks and the net declines are high when there are more declining
stocks.

This signals when the overall market sentiment is bullish or bearish.

Combining the above information, the Advance Decline line is a cumulative measure of the net
advances or declines. The Advance Decline line is based on the theory which uses the number of
advancing or declining stocks to determine whether one should buy or sell a security.

The advance decline index line should not be confused with the Advance Decline ratio or ADR
which works on the similar principle but is calculated differently. The AD line is widely used in
the calculation of other indicators such as the ARMS Index or even the AD ratio indicator.
Formula:

The Advance/Decline Index is calculated using the following formula:

Advance/Decline Index = (Advances - Declines) + Prior Advance/Decline Index Value

Advantages:

The Advance decline index line can be used in many different ways, but here are three common
uses of this indicator.

1. The AD line is used as a confirming indication to validate the strength of the trend and
also to ascertain the possibility of a reversal or a trend correction
2. The AD line can be used to confirm market tops based on increasing or decreasing
market participation. When stocks posts a high but the AD line is not confirming this high
(market participation), it signals that the highs in the security are coming off from just a few
market participation and therefore increases the likelihood of a correction from the top
3. Technical traders will find that the AD line can be used as an indicator to confirm support
or resistance levels.

Chartism Assumptions of Technical Analysis:

Technical analysis is based on three assumptions:

1. The market discounts everything.

2. Price moves in trends.
 3. History tends to repeat itself.

Types of Charts:

Line Charts

The most basic of the four charts is the line chart because it represents only the closing prices
over a set period of time. The line is formed by connecting the closing prices over the time
frame. Line charts do not provide visual information of the trading range for the individual points
such as the high, low and opening prices. However, the closing price is often considered to be the
most important price in stock data compared to the high and low for the day and this is why it is
the only value used in line charts.

Bar Chart

The bar chart expands on the line chart by adding several more key pieces of information to each
data point. The chart is made up of a series of vertical lines that represent each data point. This
vertical line represents the high and low for the trading period, along with the closing price. The
close and open are represented on the vertical line by a horizontal dash. The opening price on a
bar chart is illustrated by the dash that is located on the left side of the vertical bar. Conversely,
the close is represented by the dash on the right. Generally, if the left dash (open) is lower than
the right dash (close) then the bar will be shaded black, representing an up period for the stock,
which means it has gained value. A bar that is colored red signals that the stock has gone down
in value over that period. When this is the case, the dash on the right (close) is lower than the
dash on the left (open).
Bar charts enable traders to discover patterns more easily as they take into account all the prices,
open, high, low and close. The opening price is the horizontal dash on the left side of the
horizontal line and the closing price is located on the right side of the line. If the opening price is
lower than the closing price, the line is often colored black (or green) to represent a rising period.
The opposite is true for a falling period, which is represented by a red color.

Candlestick Chart:
The candlestick chart is similar to a bar chart, but it differs in the way that it is visually
constructed. Similar to the bar chart, the candlestick also has a thin vertical line showing the
period’s trading range. The difference comes in the formation of a wide bar on the vertical line,
which illustrates the difference between the open and close. And, like bar charts, candlesticks
also rely heavily on the use of colours to explain what has happened during the trading period. A
major problem with the candlestick colour configuration, however, is that different sites use
different standards; therefore, it is important to understand the candlestick configuration used at
the chart site you are working with. There are two colour constructs for days up and one for days
that the price falls. When the price of the stock is up and closes above the opening trade, the
candlestick will usually be white or clear. If the stock has traded down for the period, then the
candlestick will usually be red or black, depending on the site. If the stock’s price has closed
above the previous day’s close but below the day’s open, the candlestick will be black or filled
with the colour that is used to indicate an up day.
.
The top of the upper shadow represents the high price, while the bottom of the lower shadow
shows the low price. Patterns are formed both by the real body and the shadows. Candlestick
patterns are most useful over short periods of time, and mostly have significance at the top of an
uptrend or the bottom of a downtrend, when the patterns most often indicate a reversal of the
trend.

The wider part of the candlestick is shown between the opening and closing price. It is usually
colored in black/red when the security closes on a lower price and white/green the other way
around.

The thinner parts of the candlestick are commonly referred to as the upper/lower wicks or as
shadows. These show us the highest and/or lowest prices during that timeframe, compared to the
closing as well as opening price.

The relationship between the bodies of candlesticks is important to candlestick patterns.

Candlestick charts make it easy to spot gaps between bodies.

A slight drawback of candlestick chart is that candlesticks take up more space than OHLC bars.
In most charting platforms, the most you can display with a candlestick chart is less than what
you can with a bar chart.

Point and Figure Charts:

Point-and-figure is not very well known or used by the average investor, but they have a long
history of use dating back to the first technical traders. These simple charts only focus on the
significant price moves, while filtering out ‘noise’.

Point & Figure charts consist of columns of X’s and O’s that represent filtered price movements.
X-Columns represent rising prices and O-Columns represent falling prices. Each price box
represents a specific value that price must reach to warrant an X or an O. Time is not a factor in
P&F charting. No movement in price means no change in the P&F chart.

There are many varied ways to mark P&F charts from using just the close or the highs and lows.
The box size can be set to be a fixed value or a set %. The construction of point-and-figure charts
simplifies the drawing of trend lines, and support and resistance levels, which is why point-and-
figure charts are ideal for detecting trends, and determining support and resistance levels.
Trend Reversals:

Head & Shoulder:

A head and shoulders pattern is a chart formation that resembles a baseline with three peaks, the
outside two are close in height and the middle is highest. In technical analysis, a head and
shoulders pattern describes a specific chart formation that predicts a bullish-to-bearish trend
reversal. The head and shoulders pattern is believed to be one of the most reliable trend reversal
patterns. It is one of several top patterns that signal, with varying degrees of accuracy, that an
upward trend is nearing its end.

The Left Shoulder

During an uptrend, the first peak (left shoulder) forms after supply exceeds demand, leading to a
pull-back/initial retracement in an uptrend. Often, this will be the first significant retracement in
the trend, which indicates a battle between the bulls (buyers) and the bears (sellers).
The Head

After the left shoulder has formed, due to the retracement (first low of the H&S pattern), new
buyers enter the market. Bears who shorted during the retracement of the left shoulder buy back
in as well, leading to the formation of the head. The new buying power combined with the
shorters buying back in leads to a peak, higher than the left shoulder. However, buying power
decreases as buyers (bulls) get exhausted, and bears gain the upper hand again. This leads to the
second low of the H&S pattern. The second low can be higher, lower or equal to the first low in
the H&S pattern.

The Right Shoulder

After the head has formed, at the second low of the pattern, buyers attempt to increase the price
up to a new high (the Right Shoulder). However, this time they fail as sellers increase. The
inability of the buyers of increasing the price up to a new high (higher than the head) is for both
the buyers (bulls) and the bears (sellers) both a psychological turning point. The buyers will lose
confidence in reaching a higher high, and the sellers gain confidence in their stance.

The Neckline

When the right shoulder has formed, we have a complete H&S pattern. We have a third low
(after the right shoulder), bringing us to the neckline of the H&S pattern. The neckline is the last
defence for buyers (bulls) to prevent a breakdown. Once the neckline (key support) breaks, a
trend in the opposite direction emerges. As a result, those going long will go short, which will
strengthen the reversal of the trend.
The Inverse H&S pattern.

An inverse head and shoulders, also called a "head and shoulders bottom", is similar to the
standard head and shoulders pattern, but inverted: with the head and shoulders top used to predict
reversals in downtrends. This pattern is identified when the price action of a security meets the
following characteristics: the price falls to a trough and then rises; the price falls below the
former trough and then rises again; finally, the price falls again but not as far as the second
trough. Once the final trough is made, the price heads upward, toward the resistance found near
the top of the previous troughs.

The bullish variant of the Head and Shoulders pattern is the Inverse Head and Shoulders pattern.
An Inverse Head and Shoulders pattern is likely to form after a declining trend and is simply an
upside-down version of the regular H&S pattern.
Support & Resistance:

Support: is a price level where a downtrend can be expected to pause due to a concentration of
demand. As the price of a security drops, demand for the shares increases, thus forming the
support line. Meanwhile, resistance zones arise due to a sell-off when prices increase.

Support is the price level at which demand is thought to be strong enough to prevent the price
from declining further. The logic dictates that as the price declines towards support and gets
cheaper, buyers become more inclined to buy and sellers become less inclined to sell. By the
time the price reaches the support level, it is believed that demand will overcome supply and
prevent the price from falling below support.
Support does not always hold and a break below support signals that the bears have won out over
the bulls. A decline below support indicates a new willingness to sell and/or a lack of incentive
to buy. Support breaks and new lows signal that sellers have reduced their expectations and are
willing sell at even lower prices. In addition, buyers could not be coerced into buying until prices
declined below support or below the previous low. Once support is broken, another support level
will have to be established at a lower level.

Resistance:
Resistance is the price level at which selling is thought to be strong enough to prevent the price
from rising further. The logic dictates that as the price advances towards resistance, sellers
become more inclined to sell and buyers become less inclined to buy. By the time the price
reaches the resistance level, it is believed that supply will overcome demand and prevent the
price from rising above resistance.
 Advance-Decline Line
A technical indicator that plots the difference between the number of advancing stocks to
declining stocks on a daily basis
What is the Advance-Decline Line?
The advance-decline line (ADL) is a technical indicator that plots the difference between the
number of advancing stocks to declining stocks on a daily basis.
Understanding the Advance-Decline Line
The advance-decline line is used to show stock participation in a market risk or fall. Due to the
number of capitalization-weighted indices (such as the S&P 500, the DJIA, and the NASDAQ
Composite), stocks with a higher market capitalization would exert a disproportionate effect on
the performance of an index. As such, the ADL provides an indication to investors regarding the
participation of all stocks in an index in the direction of the market.
For example, if a capitalization-weighted stock index rose 3%, it would be important for
investors to know whether (1) the rise in the index was due to a majority of stocks increasing, or
(2) the rise in the index was driven by the strong performance of a company with a large weight
on the index. The ADL can be used to provide such information.
Formula for the Advance-Decline Line

Where:
 Advancing Stocks refers to the number of stocks that increased in value on a daily basis;
 Declining Stocks refers to the number of stocks that decreased in value on a daily basis;
and
 Previous Net Advances refers to the net amount of advancing and declining stocks on a
daily basis.
To fully understand how the advance-decline line is calculated, an example is illustrated below.
Practical Example
An investor is looking to create an advance-decline line for an index over a period of five days.
The investor is given the following information:
What is the ADL from Day 1 to Day 5?
ADL (Day 1) = 75 – 25 + 0 = 50
ADL (Day 2) = 40 – 60 + 50 = 30
ADL (Day 3) = 56 – 44 + 30 = 42
ADL (Day 4) = 45 – 55 + 42 = 32
ADL (Day 5) = 65 – 35 + 32 = 62
Interpreting the Advance-Decline Line
The advance-decline line is seldom used by itself. Instead, the ADL is plotted against its relevant
index. Plotting the ADL against its relevant index can help investors confirm trends and the
likelihood of reversals. Following, we illustrate four interpretations of the concept:
1. Advance-Decline Line and Index Trending Upwards
A situation where the advance-decline line and index are both trending upwards is said to be
bullish. The rise in the index is driven by the rise in the majority of stocks in the index.
As such, investors tend to believe that the market will continue its uptrend in the near future.
2. Advance-Decline Line Trending Upwards and Index Trending Downwards
A situation where the advance-decline line and index are both trending downwards is said to be
bearish. The decline in the index is driven by the decline in a majority of stocks in the index.
As such, investors tend to believe that the market will continue its downtrend in the near future.
3. Advance-Decline Line Trending Upwards and Index Trending Downwards
A situation where the advance-decline line is trending upwards, but the index is trending
downwards is said to be a bullish divergence. The decline in the index is driven by the decline in
a minority of stocks in the index. Therefore, it indicates that sellers are losing their conviction.

As such, investors tend to believe that the market will show a reversal and trend upwards in the
near future.
4. Advance-Decline Line Trending Downwards and Index Trending Upwards
A situation where the advance-decline line is trending downwards, but the index is trending
upwards is said to be a bearish divergence. The increase in the index is driven by the increase in
a minority of stocks in the index. Therefore, it indicates that buyers are losing their conviction.
As such, investors tend to believe that the market will show a reversal and trend downwards in
the near future.

Interpretation of Advance-Decline Ratio

 It is calculated by dividing the value of shares in an increasing trend by the value of
shares in a decreasing trend. Next, it determines whether the particular stock is growing
or declining in the industry. Finally, it is compared with the company's stock in which the
investor wants to invest.
 If the ratio is equal to or less than one, the stock is said to be in a stable or declining
trend.
 If the ratio is greater than one, then the stock is at an increasing trend.
 If the ratio is greater than two, the stock is at a higher increasing trend.
 Traders can estimate the market based on results or value from the formula above.
How Does it Work?
The investor compares the advance-decline ratio with the market trends and the company's trends
in which he wants to invest in, determining whether his investment will be fruitful or whether to
buy or sell the security. The ratio determines the upcoming market trend, which helps the
investor utilize the investment to earn the maximum profit. It can be calculated for any period.
Examples
Example #1
The latest market trends of the given stocks determine the advance-decline ratio.
Solution:
Advance-Decline Ratio = The Number of Advancing Stock / The Number of Declining
Stock
 =5/3
 = 1.6667
The market is said to be on an increasing trend.
Example #2
The market value of single stocks for the last ten days is calculated below.

Advance-Decline Ratio = Number of Advancing Trend / Number of Declining Trend

 = 7/3
 = 2.33
Thus, this is greater than two, showing that stock is at a higher increasing trend.
It is possible to explain the concept with the help of a chart from TradingView, as given below.
In this chart, The ratio has been used to detect whether the market is in an uptrend or a
downtrend. Overall, in the chart the area which show and uptrend will have the a positive value
as per the indicator. It will be the opposite in case of negative value.
However, even though it is a good indicator, a trader should use it in combination with other
useful indicators so that there is clarity in the process and there is proper confirmation.
Types of Advance-Decline Ratio

1. Ratio Calculated on a Trend Basis: In calculating the advance-decline ratio on a trend

basis, the stock value of the past few days is compared. If the overall result from most
days shows an increasing trend, then it is said that the market is at a growing trend, and
positive results from the investment are expected. For example, the stock shows an
increasing trend seven days out of 10 days; then, the stock is on a rising trend.
2. By the Results of Advance-Decline Ratio: If the result or value of the advance-decline
ratio is greater than one, then the market is said to be increasing. If the ratio is lower than
one, then the market is said to be a decreasing trend.
Advantages
1. Beneficial for Investors: This helps the investors plan the investment to earn the
optimum profits.
2. Determines the Upcoming Market Trend: This helps determine whether the stock is
overbought or oversold. Hence, it helps the investor and potential investor decide
whether to buy or sell.
3. Direction for Investment in Small Companies and Start-Ups: The advance-decline
ratio of a stock is compared with the projected ratio of start-ups to determine whether
start-ups will profit in the long run.
4. The Base for New and Loss-Making Companies: It helps new companies, small
companies, and loss-making companies perform better to cope with market trends.
5. It protects the investor from wrongful decisions.
6. It is one of the most powerful tools if combined with other trends.
7. It can be calculated for any period.
 What Is Technical Analysis?
Technical analysis is the process of predicting the price movement of tradable instruments using
historical trading charts and market data. As a result, investors can spot potential short- and long-
term investment opportunities. Commonly used in behavioral finance and quantitative research,
it helps analysts examine trends in securities trading.

Technical analysis allows traders to evaluate the impact of a security's supply and demand on its
price, volume, and volatility. Trading signals and price patterns obtained through this metric
accurately reflect current stock, forex, and commodities markets conditions. On the other hand,
the fundamental analysis only evaluates the company's financials (sales and earnings).
 Technical analysis meaning refers to the method of anticipating the price movement of
tradable instruments using past price actions, trade charts, and market data.
 It allows traders to assess the impact of supply and demand on a security's price, volume,
and volatility, discover short- and long-term investment opportunities, and choose when
to enter or quit the market.
 It differs from fundamental analysis, which forecasts market situations based on a review
of a company's financial statements (sales and earnings).
 The most frequent means of displaying technical analysis results are candlesticks, bars,
and line charts.
Technical Analysis Explained
Technical analysis of stocks or forex enables investors to estimate the price direction of an asset
based on historical data, such as price and trading volume. The forecasts allow traders to
understand market sentiments and decide where to invest for profits. When used in conjunction
with fundamental analysis, it is likely to provide the best return on investment.
As the buying and selling actions in the market reflect all the required information related to the
security in question, assigning a fair or true market value to the security becomes a continuous
affair. This value is what technical analysis assures and helps trace from time to time to make
relevant future price predictions.
Fundamental analysis is the means of forecasting market scenarios based on the financial
statements of businesses to evaluate the fair value of assets. This value is subject to external
factors and intrinsic parameters. On the other hand, technical analysis considers historical prices
to predict future prices.
Most traders follow fundamental analysis to decide whether to invest in an asset. And they then
use technical analysis to assess risks associated with the investment while identifying low-risk
entry prices for buying securities.

Technical Analysis Features

 Technical analysis assumes three scenarios: the market discounts everything, which
means that prices reflect all relevant information about an asset, prices follow trends or
exhibit countertrends, and historical price movements repeat themselves.
 It is conducted keeping into account the time frames and technical indicators that traders
use.
 Based on technical analysis, charts are prepared at regular intervals, for example, in 5-
minute, 15-minute, hourly, 4-hour, and daily.
Types Of Technical Analysis Charts
Technical analysis examines past price charts and patterns (that may be repeatable) for security
and forecasts future price trends. Investors can rely on it and invest per their knowledge. It can
be used to depict and predict price patterns of any asset, be it stocks, futures, bonds, fixed-
income securities, commodities, or currency pairs.

Investors analyze price movements to get an idea of the market direction and represent them on a
graph in various forms. Then, traders examine trades based on them and decide whether to invest
or wait for a better trading opportunity.
As an investor, one might find the price movements being represented in the following forms:
#1 - Candlestick
The candlesticks help investors identify trading patterns and enter a profitable trade. The patterns
are represented by combining two or more candles in a particular sequence. This representation
could be better and more useful with a single candlestick than multiple for an overall market
view. With the help of these patterns, traders can:
 Buy stronger positions and sell weaker ones – The strength is represented by a bullish
candle (normally in blue), and weakness is indicated via a red candlestick (normally in
red).
 Be flexible with patterns – The technical analysis reports tell investors how a real
trading pattern differs from those studied in textbooks. Thus, it teaches them to be
flexible with trading patterns depicted using candlesticks.
 Look for a prior trend – When current trends are bullish, it signifies prior trends to be
bearish and vice-versa.
A candlestick on an hourly chart depicts the price action for one hour, while a 4-hour stick
indicates the price action through the specified four hours in a row. The highest point of the
candlestick shows the highest security trading price, while the lowest point displays the lowest
price of that time. The candlestick's body (the thicker portions) signifies the opening and closing
prices for the period in question.
A blue candlestick means the closing price was higher than the opening price. Likewise, a red
candlestick indicates the opening price was higher than the closing price.
Single Candlestick Patterns
1. The Marubozu
Marobozu means “bald head” or “shaved head” in Japanese. This pattern is formed without
bothering about what the past trends were. It marks the formation of candlesticks with no
shadows, which shows that the security price does not go beyond the opening and closing price.
Also, it indicates the specific entry and exit points of a particular trade.
2. The Spinning Top
This candlestick might not provide specific price movement details but offers useful information
to indicate the overall current market scenario. The candle has a small real body on a spinning
top, which shows the minor difference between the open and close price. In addition, the upper
and lower shadows are almost equal, as they connect the candlestick body to the high and low
points of the day, respectively.
3. The Dojis
This type of candlestick emphasizes the expected reversals or price changes in the current
market. The pattern shows that the open and close security prices are equal. Therefore, Dojis do
not have a real body. Investors get to know about the market sentiments using these candlestick
patterns.
4. The Paper Umbrella
This candlestick pattern signifies the direction of trades at a specific period. The interpretation of
different paper umbrellas depends on where it appears on the chart. It appears on a chart in two
forms – indicating bearish trends, referred to as the hanging man, and bullish trends, known as
the hammer.
5. The Shooting Star
This candlestick pattern appears as an inverted paper umbrella but has a long upper shadow,
normally double the real candlestick body. The longer the upper wick, the more bearish the
pattern would be.
The following Nifty Bank Index chart will give individuals, especially the ones new to the world
of trading, a clear idea of how the Marubozu pattern works.

In the above chart, one can identify the bullish Marubozu because of its distinct features, which
include the large and lengthy body and little and the lack of upper and lower shadows. Since the
bullish or green candlestick appears in an uptrend, it signals the continuation of the upward price
movement. If its formation took place at the end of a downtrend, it would indicate a trend
reversal. Here, the candle shows that the bulls or buyers in the market are in complete control.
Individuals can find more single candlestick patterns like this on the official website
of TradingView to gain better understanding of the concept.

Multiple Candlesticks Patterns

1. The Engulfing Pattern
A single candlestick pattern is enough to help investors identify the trading opportunity. In a
multiple candlesticks pattern, at least two to three candlesticks are formed to understand the
pattern for making effective trading decisions. The pattern of Day 1 and Day 2 are combined to
make an accurate price pattern analysis. The Day 1 candle is smaller than the candle for Day 2,
and the latter seems to engulf the former. If the engulfing pattern is observed at the bottom, it is
bullish. But if the engulfing pattern is seen on top, it indicates a bearish market.
2. The Piercing Pattern
Unlike the bullish engulfing pattern, in the piercing pattern, the second-day blue candle partially
engulfs the lower candle of the first day, which is red.
3. The Dark Cloud Cover
Like the bearish engulfing pattern, the dark cloud cover observes the second day’s red candle
engulfing the blue candle of the first day.
4. The Morning Star
It is a bullish candlestick pattern formed by combing three consecutive candlesticks over three
days and indicates a downtrend's reversal pattern. It appears at the bottom end of a downtrend.
5. The Evening Star
While the morning star marks a bullish market, the evening star is the opposite. The latter
indicates the reversal of the uptrend. This candlestick pattern is also evolved over three-day
sessions.
#2 - Bar
Also referred to as open-high-low-close (OHLC), bar charts contain a series of vertical lines,
marking the price fluctuation range during a specific time frame. It is one of the easiest charts for
investors to interpret. They can identify the open, high, low, and close prices, all at once.
The horizontal dash on the left of the horizontal line indicates the opening price, while the
closing price is depicted on the right side of the same line. When the closing price is less than the
opening price, the line appears in black or green to indicate the rising period. On the other hand,
if the closing price is more than the opening price, the line is represented in red.
#3 - Line Charts
The line charts are formed as a link between different closing prices. This line is traced from left
to right, with only the closing prices being pointed on the graphs. These charts are the
fundamental form of technical analysis performed by experts.
The best thing about these graphs is that they help get an overall view of the past and present
market prices regarding assets investors spend on.
Technical Analysis Indicators
Experts use different indicators to analyze price movements. In addition, they perform
the technical analysis of the financial markets, ensuring the reports are accurate enough to
guide investors.

Here is a list of technical indicators that traders utilize to assess the market fluctuations for better
investment decision-making:
#1 - Moving Averages
It helps traders detect ongoing trading trends. The commonly considered moving averages for the
price levels to be checked against are 10, 20, 50, 100, and 200. If the prices go above the moving
average, the trend is an uptrend, while if the price moves below the moving average, it marks the
downtrend. Moving average is classified into three categories:
 Simple Moving Average (SMA)
 Exponential Moving Average (EMA), and
 Weighted Moving Average (WMA)
#2 - Moving Average Convergence and Divergence (MACD)
MACD suggests whether a particular trend is expected to continue or the pattern is to reverse
anytime soon. The indicator uses the MACD line, the difference between the 26 periods EMA
and 12 periods EMA, and the Signal line, which is 9 periods EMA. When the MACD line
crosses the latter from below, it indicates a buy signal. On the other hand, if the MACD line
crosses the signal line from above, investors get a sell signal.
#3 - Relative Strength Indicator (RSI)
It is one of the types of momentum oscillator, besides Rate of Change (ROC) oscillator,
Stochastic oscillator, and moving average convergence/divergence oscillator. RSI measures the
magnitude of the price fluctuation. It indicates if asset prices are in the overbought
or oversold status and the reading falls between 0 and 100. If it is above 70, the prices are in the
overbought region, while below 30, it is in the oversold zone.
#4 - Bollinger Bands
It measures the volatility of the market. Three bands are considered in which the first and third
band is +2 and -2 standard deviation, with the second one being the 20-day moving average. If
the bands expand, it indicates the stock volatility is increasing. On the other hand, if the band
contracts, traders understand the stock volatility is decreasing.
#5 - Fibonacci Retracement
It represents support and resistance levels through horizontal lines. Fibonacci retracement is a
technical pattern used to predict the predetermined levels at which the stock price or asset is
expected to halt and retrace itself. This retracement or reversal could either be upward or
downward.
The Fibonacci retracement pattern is formed utilizing the Fibonacci numbers introduced by
Italian mathematician Leonardo of Pisa, aka Fibonacci, in the 13th century. This series of
numbers is nothing but natural numbers, beginning with 0 and 1. Each next number in the series
is derived by adding two previous numbers in the row. Hence, the numbers formed are – 0, 1, 1,
2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, and so on.
Further, when the number in the series is divided by the immediate successor, the ratio obtained
is equal to 0.618 (e.g., 89/144 = 0.618). When a number in the series is divided by the number
placed two places higher, the quotient obtained is 0.382 (e.g., 55/144 = 0.382). Likewise, when a
number is divided by the number placed three places higher, the number obtained is 0.236 (e.g.,
34/144= 0.236).
These percentages determine the retracement levels and help investors predict the upward or
downward movement of the trends.
#6 - Money Flow Index (MFI)
It is a technical indicator that uses both price and volume of assets to identify the overbought or
oversold status. Like RSI, MFI also oscillates between 0 and 100. The only difference between
the two is that indications from the former are based on the price perspective. At the same time,
the latter indicates the market scenario with respect to both price and volume.
Besides the indicators mentioned above, traders also consider other options to ensure the
technical analysis reports reflect accurate price movements and depict reliable price patterns.
These include – Channel Commodity Index, Donchain, Correlation Coefficient, Price Volume
Trend, Stochastic Indicator, etc.
Example
Let us consider the following technical analysis example to understand the concept better:
Jenny decides to buy stocks of Amazon (AMZN). Hence, she conducts technical analysis to find
out past trends to ensure the deal would prove to be profitable for her. She analyzes price
movements and tracks the same for the next month. The bar chart confused her a bit, which made
her use Bollinger bands as an indicator to check how volatile the market was for Amazon.
Based on the same, Jenny asks a few questions to herself, including how she predicts the future
prices based on her observations. Finally, as she becomes sure that the market will be lenient for
the coming months, she decides to give it a chance and invests in the AMZN stock.
Uses Of Technical Analysis
The technical analysis performed by experts can help:
 Understand the market direction
 Identify price trend signals
 Determine whether a particular trend is going to continue or reverse
 Predict the future price of securities
 Identify potential trading opportunities
 Know entry and exit points in a market