Fundamental Analysis Getting Started Trading with Fundamentals

Most traders tend to use technical analysis to pick their entry and exit points when trading, and swear by those methods, but if it were really that good why are there so many variations? More importantly, why do so many technical traders lose money? The answer is quite simply that they are using charts to predict the probable future price movement, based on patterns. Now that is okay but it is only slightly different from a gambler who might say that, based on the fact that there are 36 number cards and 16 face cards (excluding the 10s), there is a 9/13 chance of drawing a numerical card and as such he will place his money on that.

Now that is acceptable if one were to view the accumulation of wealth as a gamble, but for the serious investor and trader, there has got to be a lot more than probabilities. I recall visiting a gambling website on the evening that England were playing Columbia in a recent friendly; as most people know you could place a bet on either team to win or you could wager that the match will end in a draw. Unfortunately, if your forecast were to turn out wrong you lose your money. But that is gambling and as they say: "You pay your money and you take your chances." However, there is an alternative way of making sure, easy and guaranteed money - it just requires a bit of work. In this case, by simply calculating the odds, the astute would have been able to work out that one could have placed bets on all three outcomes simultaneously and made money regardless of the outcome, albeit a return of only 3.5% to 4.8% of the total wagered. But a wise sage once said that nobody ever went broke taking a profit. The reason I use this example is to emphasise the point that even when one is involved in riskier markets/ventures it is still possible to make money with minimal risk.

This is where the fundamental trader comes into his own and, contrary to popular belief, one need not be a genius to be able to grasp and understand the way things work. What is required in any market is to be able to determine the price level at which an instrument is cheap, fair value or expensive. Based on the fact that I choose to trade shares and occasionally the UK and US indices, I will base this article on these instruments, but in truth, the same theories apply across most if not all markets.

Given that shares are a share of a business it stands to reason that as long as the profits keep going up and the cash registers keep ringing; the shares will follow suit. A very crude example is that if I own 10% of the local supermarket and the profits double over the next 5 years, I will expect my original investment to double as well (all things remaining equal).

The value of quoted shares is determined by supply and demand and whenever one or the other moves out of line, the price will end up being too low or too high. How do we determine this?

Let us assume that I am currently looking at the shares of Barclays Bank. I would start by comparing it with other banks such as HSBC, LloydsTSB, Royal Bank Of Scotland and NatWest. If we assume that the average PE ratio (price divided by earnings) of the banking sector is 12, then at any level higher than that Barclays shares are relatively expensive and at any lower level they are relatively cheap. I would now move on to another yardstick, which might be the dividend yield, and we might assume that the average yield of the banking sector is 3.8%. If Barclays shares currently yield 4.2% then they are relatively cheap on a yield basis and if they only yield 3% they are relatively expensive. There are other ratios that might be used like the Return On Capital Employed (ROCE); Book to Sales; Net Asset Value; Earnings Before Interest Tax Depreciation and Amortisation (EBITDA). The last one is, in my opinion, an absolute nonsense and one is better off ignoring it when trying to calculate fair value: it is a legacy of the Dot Com era (and a bad one at that).

If we were to assume that Barclays has a PE ratio of 10 and a yield of 4.2%, then so far so good, the next thing to take into consideration would be the company's growth prospects. The best thing to do is check the last 3 years results, which might show that it has an average growth rate of 15%. Dividing the PE ratio of 10 by the growth rate of 15 gives a figure of 0.66, this is known as the PEG ratio (any figure below 1 is generally good value).

It seems that I am on to a winner here and the last thing I would need to check before I place the buy order is that the economy is not about to collapse bringing a substantial rise in bad debts. Once I am happy that this will not happen I buy the shares in the knowledge that sooner or later, the market will wake up to the fact that the shares were previously under priced.

The whole procedure above takes less than 30 minutes and a smart 15 year old could perform this basic exercise. The beauty of it is that you would not have lost any money during the Technology bubble. Some people were buying shares that were priced based on the number of times people viewed the website. Hello? Why would I buy a fashion boutique based on the number of people that look at the mannequins through the window? It is all about sales, cash flow, profits and assets. Why would any rational thinking individual pay 1000 times earnings or 100 times sales for a company that has no assets, that was started within the last 12 months and is run by a couple of high school dropouts? The astute were busy snapping up the cyclicals, utilities, mining, banking stocks etc. that were extremely cheap on fundamentals and yielding more than bank deposits. When the music stopped, the technology speculators ended up without chairs (and in some cases they lost their beds as well).

By the time the charts told them the shares were heading for the abyss, it was too late, somewhat akin to trying to flee from a tornado or tidal wave. Ask yourself if you would put your boat out to sea if you knew that this would occur: obviously not. Neither would you head for the ski slopes if you had been told about an impending snowstorm. Fortunately, fundamentals are like the weatherman: you receive advanced warnings of the impending direction of the markets.

Whenever I see shares that are way out of line with their fundamentals I latch onto them and get ready to pull the trigger. It does not always have to be a case of buying (going long), it could be selling (shorting) - one simply reverses the criteria. A good example is Google: the speculators are piling in as if they are the best thing since sliced bread and they are currently priced around $293 per share. Now if I did not consider them good value at $115, $150, $180, $200 or even $250, why would I buy them at $293? I am either a momentum trader along for the ride, a technical trader following the steep gradient on my chart or a fool looking for gold. Before anyone says "But what about the massive profits that could have been obtained?" remember that trading with hindsight is impossible. More importantly, I used to do some work for a bookmaker and he once said, "Son it is not about the winners that you miss but the losers you do not back." These shares are strictly for gamblers and those that have a high pain threshold and in my opinion there are much better trades elsewhere.

Trading based on fundamentals may not be exciting and you are very unlikely to grab any headlines but you certainly will not be parted from all your money. Sure and steady capital growth will be your reward and you will sleep well at night. I often laugh when I hear people say that they cannot leave trades running overnight because their stops might get hit but that is because they are taking on unnecessary risk. (Am I buying shares in BP or Exxon because they are good value or because I believe oil will hit $75 per barrel? Oil reaching those lofty levels should be a bonus). Sound trading based on fundamentals does not require tight stops: whenever they are hit, it means that the analysis was wrong or the company's fundamentals have changed. You take the knock on the chin and move on because there are lots more fish in the sea.

On a final note, one does not require deep pockets to trade in this manner, as one can use spread betting which offers gearing of at least 10:1, CFDs which offer 5:1 or outright stock purchases. Depending on the method used and the number of open positions, it is possible to start and be profitable with as little as £2,500 starting capital (or something in that region). If one is astute it is quite feasible to compound the money and turn it into a large amount of capital.

 

[ducati998]

Now all the backroom politics seem to have been resolved, back into breach.

In darksiding terms, an instrument is said to be "in play" when it is actively being traded. The key clue is whether the instrument has professional participation in it or not, and if there is professional participation, then to what extent and with what regularity, you see.

Professional Participation;
Every listed stock on NYSE, AMEX, NASDAQ, has "professional participation" in the form of a Specialist, or Market Makers.

Speculative interest is "created" by a combination of factors. Volatility & Liquidity being two highly sought after by daytraders.

Any instrument that lacks consistent professional participation is suspect, and is to be avoided, in preference to an instrument that has.

Therefore, by definition, this "statement" is absurd.
There is absolutely no correlation to the "suspectness" of an equity due to the lack of liquidity,or volatility.

Issues may be described as "thin" or "thinly traded" this is a consequence of their market capitalisation..................nothing to do with the highly inaccurate term "suspect"

This presence is not continuous, alternating with periods in which, for different reasons the volume is either not so great or even minimal, it does not materially matter, because the point of initial interest is whether the instrument is capable of attracting professional interest in the first instance. This is the single most important factor to initially consider.

To consider for what exactly?
To daytrade it, or from an investment "quality" perspective?

If the latter, then as usual, you are incorrect.

Now, as I ventured to explain in a previous post on this thread, and we will attack the question from a slightly different angle in order to properly profile the matter. An instrument that is not healthy is not going to be traded consistently, This is because ot three major ultimate or extreme risks, being the risk of (a) delisting (b) suspension (d) illiquidity.

Absolute twaddle.
Volume, or liquidity has absolutely no bearing on creditworthiness.
And, actually in point of fact, the most "Financially unsound" companies will very often have huge volume surges, increasing their liquidity and marketability dramatically.

In consequence of what I explain above, the fundamental considerations utilised in stock selection are not altogether invalildated, but they are to some extent eclipsed. This is because skilful reading of the chart, meaning gaining the "footprint" of the behaviour and likely behaviour of the instrument is able to clearly reveal phases of accumulation and distribution in it, which are professioally instigated and executed, with military precision.

Lets take it back down a few notches, the altitude is robbing your brain cell of oxygen.

Fundamental considerations are NEVER invalidated.
They will tell you exactly the position of the stock.
That position may well, as in GOOG's case be a speculative frenzy, in which, we the Fundies do not belong, it is a stock for momentum traders plain & simple.

Accumulation & Distribution can be measured accurately by the fundamentals.
It can only be implied via Technicals.

Each instrument has its own footprint. Each footprint is distinctive. This is because the professional interest in it specific. The specificity of proffessional interest is what gives the footprint its character. Thus character change implies change in proffessional interest. Change in proffessional interest occurs for a reason. It does not matter what that reason may or may not be, but the shift in emphasis is the clue.

Insider buying & selling, is "professional" interest, but somehow this is not I suspect to what you were referring.

The footprint that you are referring to, perchance "volume" analysis?
In a highly volatile speculative stock, a waste of time.
The other "professional" you need to watch is the Specialist or Market Maker. You will never see his hand till the hammer falls.

Don't waste my time bleating about Level2, or Time & Sales, one is historical, and you've missed the boat, the other is manipulated well beyond anything you see on screen.
What you need to see is the ORDER BOOK.
And that you will never see.

This sudden shift in emphasis is immediately revealed in the price action. This price action is recorded on a chart. The volume attributable to this action (or the absence of it) is also shown. Together, they indicate to the skilled observer what is the most likely probable outcome, and all of this in real time, as and when the action is developing.

Of course it is..........................duh.
P&V, just momentum trading, nothing less, nothing more.

Having said this, what really interests me is the professional posture, which is what I follow.

In your dreams.

This is because the public is not empowered to push prices up or down. The public is led, the public does not lead. Therefore from my viewpoint public opinion is not something I pay attention to at all, but instead consider proffessional activity to be the beacon

So all those Billions of dollars of "the publics money" in Hedge Funds, Mutual Funds, Pension schemes etc, have no influence....................think again, your lack of understanding is monumental.

With regard to all the lines, you know, we all have to start somewhere. It is more a matter of evolvement and trading maturity rather than convenience. I do not use any indicators whatsoever. I just read the development of price against volume as these unfold, bar by bar at a mechanical level, I read the tape at a proactive level, and I read the price inference at an intuitivve level, the intent at what you could say is a futurological level, and that is the Analytical Blending that is the basis for my work.

You are a fantasy artist no doubt about it.

You see, in my early days I also used to subscribe to that viewpoint but it has hardened over the years into being able to adopt a professional posture devoid of any emotions, and for this reason I deal with all of it from what is necessarily a professional standpoint. This causes me not to consider the psychological element but only the stark cold reality of what unfolds.

Markets are at their core psychological, and accounts for their large swings in valuation, that is devoid of any reason, logic, or analytical thought.

Understanding this basic truism, allows those who can recognise emotional extremes via a valuation will provide a very quantifiable methodology with which to engage the market.

That you choose to ignore it, or even more unforgiveable, not even realise the component of psychology contained in "price" highlights your incomplete, and limited understanding.

cheers d998

 

[RUDEBOY]

Can you trade FA intraday? Realistically? R.

 

[ducati998]

RB,

Realistically.....................no. You would have to make far too many adjustments and compromises.

cheers d998

 

[RUDEBOY]

Who makes the first move? And can thier move be counteracted? What about 'gangs' on the market? Conspirancy? Think about it? Who's in who's pockets? Now that's FA?

 

[RUDEBOY]

Ducatti, we finally agree on something! No, honestly though, FA is limited.

 

[ducati998]

RB,

"Limited"...........yes indeed, limits your mistakes, your losses, your profits, and your loss of sleep, poor health, and hyperactivity in the market, but not on these boards.

cheers d998

 

[SOCRATES]

Now all the backroom politics seem to have been resolved, back into breach.



Professional Participation;
Every listed stock on NYSE, AMEX, NASDAQ, has "professional participation" in the form of a Specialist, or Market Makers.

Speculative interest is "created" by a combination of factors. Volatility & Liquidity being two highly sought after by daytraders.



Therefore, by definition, this "statement" is absurd.
There is absolutely no correlation to the "suspectness" of an equity due to the lack of liquidity,or volatility.

Issues may be described as "thin" or "thinly traded" this is a consequence of their market capitalisation..................nothing to do with the highly inaccurate term "suspect"



To consider for what exactly?
To daytrade it, or from an investment "quality" perspective?

If the latter, then as usual, you are incorrect.




Absolute twaddle.
Volume, or liquidity has absolutely no bearing on creditworthiness.
And, actually in point of fact, the most "Financially unsound" companies will very often have huge volume surges, increasing their liquidity and marketability dramatically.



Lets take it back down a few notches, the altitude is robbing your brain cell of oxygen.

Fundamental considerations are NEVER invalidated.
They will tell you exactly the position of the stock.
That position may well, as in GOOG's case be a speculative frenzy, in which, we the Fundies do not belong, it is a stock for momentum traders plain & simple.

Accumulation & Distribution can be measured accurately by the fundamentals.
It can only be implied via Technicals.



Insider buying & selling, is "professional" interest, but somehow this is not I suspect to what you were referring.

The footprint that you are referring to, perchance "volume" analysis?
In a highly volatile speculative stock, a waste of time.
The other "professional" you need to watch is the Specialist or Market Maker. You will never see his hand till the hammer falls.

Don't waste my time bleating about Level2, or Time & Sales, one is historical, and you've missed the boat, the other is manipulated well beyond anything you see on screen.
What you need to see is the ORDER BOOK.
And that you will never see.



Of course it is..........................duh.
P&V, just momentum trading, nothing less, nothing more.



In your dreams.



So all those Billions of dollars of "the publics money" in Hedge Funds, Mutual Funds, Pension schemes etc, have no influence....................think again, your lack of understanding is monumental.



You are a fantasy artist no doubt about it.



Markets are at their core psychological, and accounts for their large swings in valuation, that is devoid of any reason, logic, or analytical thought.

Understanding this basic truism, allows those who can recognise emotional extremes via a valuation will provide a very quantifiable methodology with which to engage the market.

That you choose to ignore it, or even more unforgiveable, not even realise the component of psychology contained in "price" highlights your incomplete, and limited understanding.

cheers d998

You can rant and rave as much as you like, ducatti, but I make my statements and stick to them, and I am not elaborating for your benefit other than that which I choose to post publicly for everybodys' benefit. Nor am I answering any of your stupid questions. Now you can go off and contemplate your navel. Absolute tedious and repetitive bore you are.

 

[RUDEBOY]

Mmmm, that's only from a personal perspective, i take it? Besides i meant it from an analytical point of view, not a methodic one.

 

[RUDEBOY]

General, can i also add, not personal!

 

[RUDEBOY]

I can see myself explaining this one in very simple terms, Ducatti!

 

[RUDEBOY]

Right! Can FA cover the whole of the markets, no matter what instrument you choose? If yes, would you bother? If yes, give me an example! This is not personal, i just need to know your extremes of FA. Was it worth it? Remember, truth, Ducatti? Just be truthful to yourself at least! FA alone can not be worth every instrument? RB.

 

[SOCRATES]

Right! Can FA cover the whole of the markets, no matter what instrument you choose? If yes, would you bother? If yes, give me an example! This is not personal, i just need to know your extremes of FA. Was it worth it? Remember, truth, Ducatti? Just be truthful to yourself at least! FA alone can not be worth every instrument? RB.

RUDEBOY, you are not going to get a response from him because you are not the focus of his obsession and his frustration. I am. And I am because I refuse to give him what he so desperately wants, that's all. Simple really.

 

[RUDEBOY]

Ducatti, lets hope the weekend thread escapes 'personallity'. This could become your downfall! Don't loose it. Rude.

 

[ducati998]

RB,

Right! Can FA cover the whole of the markets, no matter what instrument you choose? If yes, would you bother? If yes, give me an example! This is not personal, i just need to know your extremes of FA. Was it worth it? Remember, truth, Ducatti? Just be truthful to yourself at least! FA alone can not be worth every instrument? RB.

If it can be accurately valued, then the "Fundamentals" are valid.
Lets take the most difficult as an example.

Currencies.
Can you accurately value a currency? Buffett is trying, and see the article on DJI Value or Water, currently, is getting hurt, via the collapse of the Euro.

Would I try to value a currency................no, too hard for me, therefore, for myself, FA, has limitations.

cheers d998

SOCCY.................see you at Christmas!!

 

[SOCRATES]

RB,



If it can be accurately valued, then the "Fundamentals" are valid.
Lets take the most difficult as an example.

Currencies.
Can you accurately value a currency? Buffett is trying, and see the article on DJI Value or Water, currently, is getting hurt, via the collapse of the Euro.

Would I try to value a currency................no, too hard for me, therefore, for myself, FA, has limitations.

cheers d998

SOCCY.................see you at Christmas!!

You see, RUDEBOY, you see ?

Aw alright ducatti, we will see when the time comes..

 

[ale]

As a newcomer trying to validate a first paper system I must say that I am bemused by the above. It does not help me one iota to have spent a couple of hours deciphering this thread. I was beginning to get comfortable with TA and a bit of FA when the original article (remember that?) made me reconsider.
So, Socrates has a system that presumably makes money. Similarly Ducati998. THEY ARE BOTH RIGHT - YES ????
Now I am on the dark side - well, in a darkened room with a glass of merlot wondering if my brain can take any more!

 

[SOCRATES]

You must not allow any of this to give you a migraine headache please.

What happens is that very few actually take the trouble to get to grips with Fundamental Analysis because in mainstream terms it is unjustifiably seen as tedious and laborious, so the tendency is for newbies to be attracted instantly to the apparent attractions of Technical Analysis, in the erroneous belief that if it cannot be mastered in two weeks, well, you know, there is plethora of suggested solutions tantalisingly available.

Nearly all of these suggested solutions hinge on what in popular parlance are described as "systems". If you trawl through this website carefully and diligently you will not fail to observe that the threads that have the greatest number of hits are those that are devoted to discussion of these "systems". This should tell you a lot. It should strike you that the great majority are constanly on the lookout for an easy solution, and if there is no effort required, so much the better.

Unfortunately the world of trading is not like that at all. This presents a huge shock to most people that they find difficulty coping with. This is understandable, but in trading terms not acceptable. You see, Technical Analysis (real technical analysis) is not guesswork. This is because it records the reality of price progression and when combined with volume, indicates clearly to the skilled observer the reasons for these price progressions. This is an acquired skill. It is a skill of observation. But this skill of observation has to be underpinned with a very complete understanding of how markets work and are made to work under a huge variety of interrelated circumstances and specific scenarios. You can now see that to take on the mission of mastering the technique properly is a huge undertaking.

As a separate adjunct a similar situation arises around the topic of Fundamental Analysis. The perception of the newbie is that you have to be an Actuary or a Chartered Accountant, or even a Bookeeper, or even an Economist to be able to get to grips with it. This puts people off again, as they do not percieve themselves capable of undertaking such an odessey, and in consequence gravitate elsewhere, being taking tips, brokers's advice, of looking for a "system" or such like.

Now there is a misconception that Technical Analysis is the complete anthiposis of Fundamental Analysis. And if you happen to come across threads such as this one, on first inspection you are bound immediately to arrive at the conclusion that a battle rages between one group and another.

But the fact of the matter is, that there are very few who go on to master one skill set, let alone both. At its most elevated and developed level Technical Analysis is percieved to be almost an art form. This is not correct either. It is just that having attained mastery and the gaining of a definitive edge, the holders of that edge cannot be expected to reveal or discuss their edge in public, as this would negate the object of the excercise, you understand.

This leads everyone to all sorts of misconceptions about the topic, including the belief that Technical Analysis is gambling. This could not be further from the truth. Technical Analysis may seem like gambling but I assure you that in the hands of really skilled practitioners it is not.

Similarly a myth has been created around Fundamental Analysis, that it is difficult, tedious and slow.
At the heart of Technical Analysis lies Fundamental consideration, that is the consideration of Fundamental Principles. So it is not as if the topic is split in two, it is that each skill set fulfils a separate function, that, when put together, fulfil a common objective.

I hope that this serves to clarify your puzzlement somwhat.

 

[LION63]

Ale,

On the contrary, the posts here should have revealed to you that if you wish to be a day trader fundamental analysis is not for you and it would be better to stick to technical analysis. It should also show you that day trading is like shooting from the hip and you face the prospects of hit and miss ie. you will have a low strike rate. That will not stop you from being profitable if you are as proficient as a handful of the members on these boards, but they are the select few.

If you wish to join the select few you will have to find a suitable method and work at it until you become very proficient, that takes time and a lot of hard work but the rewards are vast. Fundamental and technical analysis both have their place and merits it comes down to choice.

I put the article together in order to show that there are alternatives to technical analysis which almost all the members on these boards follow. In a recent poll only two traders (Ducati and I) claim to use fundamental analysis, some might come to the wrong conclusion that fundamentals are a waste of time which is not the case. Evidence of this is shown in the statistics that about 90% of traders lose money, now if 99% of the traders here follow technicals and only 10% are profitable, what does that tell you? What does it profit you to join the slaughtered?

 

[ducati998]

ale,

As a newcomer trying to validate a first paper system I must say that I am bemused by the above. It does not help me one iota to have spent a couple of hours deciphering this thread. I was beginning to get comfortable with TA and a bit of FA when the original article (remember that?) made me reconsider.

Then the article has done it's job.
It was written in the context of providing some "exposure" to the "Fundamental" paradigm, as this forum is predominantly "Technical" in it's posture.

So LION63 has succeeded in giving you pause for thought, and in that pause, you may look a little more closely at alternatives that are available to you.

cheers d998

 

[Tuffty]

Fundamental Data Sources UK Equities:

I don't think anyone has mentioned data sources so here's my list. The 'bible' for starting to look at fundamentals in UK equities is a product called 'Company REFS' available in CD, book or internet form from HS Financial Publishing, see www.companyrefs.com

For daily UK company news and results the RNS (Regulatory News Service) is available on many financial sites. I use www.uk-wire.com

Also you can get the annual reports from the companies directly. The best fundamental information made available by companies is unfortunately only published when they're floated so getting the prospectus on new companies floats can make interesting reading.

Then of course there is 'scuttlebut'. Speaking to the companies directly, or competitiors, customers, AGM's, company visits etc etc