2013

FUNDAMENTAL AND
TECHNICAL ANALYSIS
OF STOCK MARKETS
National Convention for CA Students Mumbai
Technical Session 1 Investment Opportunities

GAURI SHRIPAD ARAVKAR

VIVEK DOSHI & CO

Fundamental and Technical Analysis of Stock Markets

Contents
Stock Valuation Meaning and Methods of Valuation .................................................................... 3
Fundamental Vs. Technical Analysis Birds Eye view ..................................................................... 4
Role of Fundamental and Technical Analysis in Determining Stock Price ....................................... 5
Methodology used in Fundamental Analysis .................................................................................... 6
Methodology used in Technical Analysis .......................................................................................... 7
Balanced Application of both analysis necessary ........................................................................... 13
Case Study: Failure of Analysis in the light of Stock Manipulation ................................................ 14
References ........................................................................................................................................ 16

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Fundamental and Technical Analysis of Stock Markets

Stock Valuation Meaning and Methods of Valuation

Stock valuation is the method of calculating the theoretical worth of a companys
stock and thus that of the Company. The need of stock valuation arises for
variety of financial decisions few of which are listed below:
1.
2.
3.
4.
5.
6.

Investment Analysis
Capital Budgeting
Merger and Acquisition
Financial Reporting
Determining Tax Liability
Litigation

However, this paper focuses on the valuation of stock markets for facilitating the
investment decisions so as to make maximum profit.
The stock market is like a flea market where people buy & sell pieces of paper
called stock. There are owners of the corporations who want to raise money to
hire more employees, build factories or offices. They raise money by issuing
shares of stock in their corporation. On the other side, there are investors who
buy shares of stock in the corporation. The place both sides meet is the stock
market.
There are two basic methods for determining what stock to buy and sell Fundamental Analysis and Technical Analysis.

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Fundamental and Technical Analysis of Stock Markets

Fundamental Vs. Technical Analysis Birds Eye view

In a shopping mall, a fundamental analyst would go to each store, study the
product that was being sold, and then decide whether to buy it or not. By
contrast, a technical analyst would sit on a bench in the mall and watch people
go into the stores. Disregarding the intrinsic value of the products in the store,
the technical analyst's decision would be based on the patterns or activity of
people
going
into
each
store.

Fundamental
Analysis

Financial Position

Technical
Analysis
Chart and Trend
Analysis
Dow Theory

Balance Sheet

Financial Performance
Profit & Loss Account
Ratio Analysis

Past Prices and

Volume
Moving Average,
Support and
Resistance,Relative
Strength Index

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Fundamental and Technical Analysis of Stock Markets

Role of Fundamental and Technical Analysis in Determining

Stock Price
Fundamental analysis as it name signifies analysis of fundamentals of company
and economy analysis. Balance sheet is the back bone of a company. A good
company has strong balance sheet and fundamental analyst try to find the
intrinsic value of company by analyzing the balance sheet, Growth rate, Profit
and loss, Cash flow, Industry analysis and economic analysis. So in nut shell a
good company has high growth rate, low leverage, good management, and Low
P/E ratio compared with peers, Low debt-Equity Ratio.
Fundamental analysis is good for investment but main problem with fundamental
analysis is Difficulty in getting in depth information of company, lot of resource
is required for fundamental analysis and for most investor it is out of their hand,
unavailability of hidden news and difficulty to judge the companys valuation etc.
Here comes the importance of technical analysis.
Technical analyst uses the demand supply theory to judge the price and they
believe past price movement will have an impact on future movement also.
Share price increase or decrease whenever there is a change in fundamental and
it will be reflected in its demand/supply and in turn it will affect the price. So
technical analyst uses historical price/volume to judge the future price
movement of stock. He uses charting software and uses various tools like
moving average, oscillator to find the support level - share price at which there
is demand for share-Buy will occur and resistance level - share price at which
supply will occur-sell happens of share.

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Fundamental and Technical Analysis of Stock Markets

Methodology used in Fundamental Analysis

Economy
Analysis

Industry
Analysis

Company
Analysis

Economy Indicators
Social Indicators
Investment Scenario
Stock market Analysis
Sovereign Rating

Size and Dynamics

Industry Life Cycle
Demand Drivers
External Factors
Future Outlook

Competitive Position
Distinctive Edge
Segmental Analysis
Financial Analysis
Growth Prospects

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Fundamental and Technical Analysis of Stock Markets

Methodology used in Technical Analysis
Technical Analysis is based on the following assumptions:
The market discounts everything
Prices move in trends
History tends to repeat itself
Stock prices move in trends that persist for long periods. These trends can
be detected in charts. Thus past trends in market movements can be used
to forecast or understand the future. The lag between the time, a
technical analyst perceives a change in the value of a security and when
the investing public ultimately assesses this change provides a profit
opportunity to the chartist.
Dow Theory
Averages discount everything.
The market has three trends.
Major trend have three phases.
Volume must confirm the trend

This theory was first stated by Charles Dow.

Primary Trend Called the tide by Dow, this is the trend that defines the
long-term direction (up to several years).Secondary Trend Called the
waves by Dow, this is shorter-term departures from the primary trend
(weeks to months)

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Fundamental and Technical Analysis of Stock Markets

Eliot Wave Theory

Elliot stated that stock market moves in repetitive cycles. The Elliot Wave
Principle is based on a repeating 8-wave cycle, and each cycle is made up of
similar shorter-term cycles. These waves have a rhythmic pattern and these
patterns can be used to predict future prices of stocks and predict trends of the
market. These waves move with investor psychology i.e. waves show an upward
trend when crowd is positive and too much positivity leads to a downward trend
in the wave.

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Fundamental and Technical Analysis of Stock Markets

Trends
The meaning of trend in finance isn't all that different from the general definition
of the term - a trend is really nothing more than the general direction. A trend
represents a consistent change in prices (i.e. a change in investors
expectations) A trend line is a simple charting technique that adds a line to a
chart to represent the trend in the market or a stock.
Types of Trends

1. Uptrend

2. Downtrend

3. Sideways Trend

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Fundamental and Technical Analysis of Stock Markets

Support and Resistance
Support level is a price level where the price tends to find support as it is going
down

Resistance level is a price level where the price tends to find resistance as it is
going up

Importance of Support and Resistance Support and resistance analysis is an

important part of trends because it can be used to make trading decisions and
identify when a trend is reversing
Support and Resistance levels Support and Resistance levels are highly volatile
Traders should not buy and sell directly at these points as there may be
breakout also.

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Fundamental and Technical Analysis of Stock Markets

Breakout
The penetration of support and resistance level is called breakout

Traders Remorse
Returning to the level of support or resistance after a breakout is called traders
remorse.

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Fundamental and Technical Analysis of Stock Markets

Volume Indicators
A mathematical tool that can be applied on securitys price giving a result that
can be used to anticipate trends, volatility and price Indicators are used in two
main ways: to confirm price movement and to form buy and sell signals.
Moving Averages
A simple moving average is calculated by taking average of most recent closing
prices of n time period. Sometimes traders use two moving averages to
determine buy and sell decisions. Using a slow moving average (more days)
together with a fast moving average (fewer days) generates the following
trading strategies:
Buy when the faster moving average crosses the slower one (from below). Sell
when the faster moving average crosses the slower one (from above).
Buy when prices are above both the fast and slow moving averages. Sell when
prices are below both the fast and slow moving averages.
As with most tools of technical analysis, moving averages should not be used on
their own, but in conjunction with other tools that complement them. Using
moving averages to confirm other indicators and analysis can greatly enhance
technical analysis.
Relative Strength Index (RSI)
It compares the magnitude of recent gains to recent losses in an attempt to
determine overbought and oversold conditions of an asset
RSI= 100- 100/ (1+RS)
RS=EMA [U]/EMA [D] EMA- exponential moving average
U= Sig (close (today)-close (yesterday))
D= Sig (close (yesterday)-close (today))

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Fundamental and Technical Analysis of Stock Markets

Balanced Application of both analysis necessary

No one method can give you the holy grail of profits. But what good traders and
investors can do is combine methods to provide a clearer picture of what is
happening and how to take advantage of opportunities in the share market.
No matter how you slice and dice the numbers, investing and trading is all about
choosing companies that are likely to increase in value for two main reasons:
1. The underlying business show potential and
2. Market forces are acting in its favor.

In the short run, strong fundamentals do not always indicate strong technical
patterns or vice versa. Often, technicals can continue to follow a strong or weak
pattern when fundamentals are at turning points, which may lead them to be out
of sync. Additionally, technical can be out of sync with fundamentals when there
is a shock to a stock, either positive or negative. Stocks tend to follow technicals
in the short run unless there is an unforeseen shock. Technical analysts say you
can respond real time to a stock and not have to wait for the next reporting date
or news disclosure, because the charts already interpret market sentiment, so
following the charts will lead to higher profits. Technical analysts believe that
stocks move even without disclosures because suppliers, competitors and
employees, invest in companies and without needing inside information, get a
sense of how the company is faring. These buying and selling activities define
the stock chart and pattern, and reflect the real-time stock behavior.

Therefore, even if the two have been out of sync in the short run, technicals and
fundamentals should be in sync in the long run. That's because in the long run,
fundamentals should win and drive the technical.

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Fundamental and Technical Analysis of Stock Markets

Case Study: Failure of Analysis in the light of Stock

Manipulation
Ketan Parekh Scam
A Mumbai based stock broker chartered accountant by profession
KP took advantage of low liquidity in certain stocks which later came to be
known as K- 10 Stocks
Held significant stakes in the K- The buoyant stock10 companies
markets from January to July 1999 helped the K-10 stocks increase in
value substantially
As a result other brokers and fund managers started investing heavily in
these stocks
The K-10 Stocks
1. Aftek Infosys
2. Himachal Futuristic Communications
3. Global telesystems
4. DSQ software
5. Silverline Technology
6. Satyam computers
7. Pentamedia Graphics
8. Pritish Nandy Communications
9. Zee Telefilms
10.SSI
How it happened?

Formed a network of brokers

Identified and targeted 10 stocks
K-10 stock, KP Index
Zee telefilms went up from Rs. 127to Rs. 2330, Himachal Futuristic Rs.
194 to 2553

Badla System
Indigenous carry-forward system invented on the Bombay Stock
Exchange
Badla trading involved buying stocks with borrowed money.
The stock exchange acts as an intermediary Interest rate determined by
the demand for the underlying stock
Maturity not greater than 70 days

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Fundamental and Technical Analysis of Stock Markets

How it happened?

When stock prices were high, they were pledged with banks as collateral
No problems as long prices were rising
Pay order fraud
Issued cheques to MMCB drawn on BOI
Went to BOI, SBI, and PNB and got pay orders discounted

How was it detected?

Stock market crash of 2000

KP started borrowing heavily
Attempted to rig the price upwards and later sell
But failed to do so due to the pressure exerted by International bear
cartel
IT department found discrepancies in sources of funds of KP
Routine market surveillance of 5 stocks
Systematic Flaws
Trading system lag of one week
Credit Check
High exposure allowed
Lack of records and margins at Calcutta stock exchange
Lending without proper collateral

Implications
One of the biggest Fall in BSE -700 points
KP and other traders were banned from trading for 17 years
Short selling was banned for 6 months.
Badla system was banned
All shares that were put as collaterals should be done so through NSE and
BSE.
Options and Index Future derivatives was introduced
10% additional deposit margins

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Fundamental and Technical Analysis of Stock Markets

References
www.wikipedia.org/
www.investopedia.com/
http://www.slideshare.net/

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