SINGAPORE (Feb 27): Like any successful business or investment venture, “buy low, sell high” is probably the first piece of advice you will receive.
The same piece of advice applies when buying shares on the stock market. This may sound painfully obvious, but following it isn't as easy, and it takes a lot of hard work.
Now, how do you begin? By doing your research, of course!
There are two main types of methods when it comes to determining when is a good time to buy or sell a particular stock. If you are looking for a long-term investment, you should apply Fundamental Analysis. For shorter-term investing and trading, look to Technical Analysis.
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What is Fundamental Analysis?
Fundamental Analysis is the study of a number of factors that may have an influence on the company’s performance. These include a company’s financial health, business performance, the health of its industry, as well as the state of the economy.
These factors, which are also known as stock market fundamentals (hence the name), help determine the intrinsic or fair value of a company. These will in turn help the investor see if the stock is overvalued or undervalued, which may eventually affect the price of the company’s shares on the stock market.
You may have seen some news reports on analysts giving certain stocks “buy” or “sell” recommendations.
These conclusions are based on the findings done through Fundamental Analysis. If a stock is found to have been undervalued on the stock market, a “buy” rating or recommendation is given. Accordingly, if the opposite happens, a “sell” rating or recommendation will be given.
There is a third rating, “hold”, which means that the company’s share prices are performing as expected.
People who use Fundamental Analysis to determine which stocks are being undervalued, are also known as value investors. Notable value investors include Michael Burry (you may know him from the award-winning film, The Big Short), Benjamin Graham, Joel Greenblatt, and of course, Warren Buffett.
See how value investing worked for Tong's Portfolio here.
How to apply Fundamental Analysis?
There are certain metrics or ratios that investors usually look at. These include price-to-earnings (or P/E) ratio, price-to-book (or P/B) ratio, price-to-sales (P/S) ratio, and dividend yield for instance.
To better understand how these ratios are calculated, here is a guide to analysing financial statements.
Beyond these metrics, you will also have to understand the company and the nature of its business to understand some of the decisions it makes.
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What is Technical Analysis?
Technical Analysis is a method that looks at the historical performance of a company’s share price, and studies its patterns to predict future price trends.
Technical Analysis can also be seen as a form of studying market psychology. Stock prices rise and fall due to certain events that happen, and most of these correspond to investor’s emotional interests.
While fundamental analysts look at investments to invest in for the long-term, Technical Analysis is for investors or traders who are looking at shorter-term gains. Why? The market is unpredictable, and without studying the fundamentals, you may not know how well or badly the company’s business is doing.
That said, these two methods are not exclusive to one another. They can be used concurrently. For instance, after studying the company’s fundamentals, investors can study the stock’s price patterns to determine when is the best time to enter the market.
How to apply Technical Analysis?
You start with these concepts: support and resistance, simple moving average, Moving Average Convergence Divergence (or MACD), trend lines, and retracement levels. You will also need to know how to read candlestick charts.
a. Support and resistance
When analysing chart patterns, you will notice certain areas, where there is a pause in a downward or upward trend. These are what technical analysts call support and resistance. Support is when a downward trend looks up momentarily due to a surge in demand. Resistance refers to a pause in an upward trend due to an injection of supply.
These points allow for investors to either enter or exit the market, as a change in direction may occur around these areas.
Sometimes, areas of support and resistance can be broken, which leads to new trends. When that happens, new areas or levels will be formed.
b. Simple Moving Average
This refers to the average stock price that is calculated over a fixed time period. The length of the time period varies from five days, to 20, 30, 100 days, or even up to a year. The Simple Moving Average is derived by taking the total sum, and dividing it over the number of days or months that was first determined.
For example, if you are looking at the monthly Simple Moving Average in 2019, you take the average price per month, and do so, until you have reached all 12 months. Then, plot the numbers on a standard plotting graph, and see what the patterns tell you.
c. Moving Average Convergence Divergence (or MACD)
The MACD is used to chart the movement of the difference between moving averages – whether it is going upwards (bullish), or downwards (bearish). The divergence between the “faster” and “slower” lines, which indicate how quickly or slowly a price fluctuates, represents the forming of a new trend. The opposite, where the “faster” and “slower” lines meet, is called a convergence.
d. Trend Lines
Trend lines help indicate a, well, trend, or pattern. These are drawn through points at the highest and lowest price indicators to determine if the share price is going upwards or downwards. Depending on the angle of the line, trend lines also help investors see how slow or fast share prices are moving. Traditionally, steep angles occur for shorter periods of time, as drastic price drops or increases, are not as sustainable.
An example of a candlestick chart for Facebook. The figures on the right are the retracement levels. The empty candle means the price closed higher than it opened, and the blue candle means the other way around. Photo: Bloomberg terminal
e. Retracement levels
These are derived from the highest and lowest points of a share price throughout its history, and are used to plot the horizontal line markers on a chart.
Retracement levels are also known as Fibonacci retracement levels. The golden ratio of 1.62, or markers at 23.6%, 38.2%, 61.8%, or 78.6% are used to help plot the horizontal lines in between the highest and lowest points. As Fibonacci numbers are found throughout nature, investors believe they have some influence on the stock market as well.
f. Candlestick charts
A candlestick chart is so named for its resemblance to candlesticks, and it tells the movement of a share price within the time frame stipulated. For instance, if you are looking to find out the movement within the day, the top or bottom line of the body indicates the open price. The other end includes the close price. The highest and lowest prices marked during the day are represented by the “wicks” or shadows.
A green candle or empty candle means the price closed higher than it opened. A red or black candle means the opposite.
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