Technical Analysis of Stocks & Commodities

Technical analysis started out with pretty simple concepts. Formerly, it was about looking for directional trends in prices and divergences between related market indexes.  When the stock prices start moving in one direction either upper or lower, then they are more likely to follow that trend than to reverse. Technical analysis was just a way to visualize this perception.

When I started to trade in the market, I usually rely on the market moves driven by the news. But frankly speaking, I never made money after following this approach. But when I am started to learn and follow technical analysis I started to gain from the market.

I have discussed few basics below about Technical Analysis which would help you to understand and trade in the market:

Price Trends:

Price Trends indicates the current direction of share prices. Is the price of the stocks moving upper or lower? How long has it been doing so? If the stock prices continue to rise higher, it is considered to be in an uptrend and when the stock prices continue to fall it is considered as a downtrend. Uptrend indicates increasing demand for shares, as buyers are willing to pay higher prices as supply diminishes. On the other hand, Downtrend indicates increasing supply of shares when not much buyers are interested to buy the shares. You can generate trend line by connecting the various high and low points on a chart. Now from this generated trend line, you can pinpoint support/resistance and direction of stock prices. For better understanding, you can compare your current trend line with the historical trend line of the similar stocks.

Trendline

Volume:

Volume tells us how strong the prevailing trend might be. Decreasing volume can be a signal that the trend might be on the edge of a reversal.  The number of shares or contracts that traded over a given period is called Volume. Volume is important because it helps us to confirm the reversal trend.

For example:

Suppose stock X is in a downtrend at the moment. If tomorrow it increases 5% high then traders can think the stock’s downtrend is over and they could start accumulating stock X. But for the confirmation traders should always check the volume of the stock on that particular day. If the volume does not increase subsequently then it is not a trend reversal. This might be a fluke.

Volume

Moving Averages:

Moving Averages are the most commonly used technical indicators. This indicator helps you to distinguish between typical market fluctuations and actual rate reversals. Moving averages make you easier to spot trends, something that is mainly helpful in volatile markets. They also form the building blocks for numerous other technical indicators and overlays.

Simple Moving Average (SMA)

The Simple Moving Average (SMA) is the most popular type of moving average and it is generated by calculating the average price of a financial market over a chosen period of time. To compute the simple moving average you need to do a fairly basic calculation. Firstly, you need to add a stock's closing prices over a set number of days, and then divide the addition by the total number of days. For example, stock X’s closing prices for 14 days –250, 240, 245, 242, 247, 255, 251, 260, 254, 262, 270, 280, 269, 271 respectively.

So the moving average is = (250 + 240 + 245 + 242 + 247 + 255 + 251 + 260 + 254 + 262 + 270 + 280 + 269 + 271/14) = 256.86

It indicates if the stock X stays above 256.85 then it can be considered as positive sign in short term say for 14 says.

With every new day, the latest closing price replaces the oldest closing price in the calculation.

Simple Moving Average

•    Moving averages help in the smoothing out of price action.

•    Moving averages are used not only to recognize the direction of the stock’s price trend but also for trade entry.

Weighted and Exponential Moving Averages

Weighted and exponential moving averages give greater significance to a stock's most recent closing prices rather than Simple Moving Averages.  Calculation of weighted moving average is almost similar with simple moving average calculation.  Heavier weightings are allocated to the utmost recent closing prices in the data set to confirm the moving average replicates recent trends and fluctuations.

Simple Moving Average VS Exponential Moving Average

 

SMV VS EMA

 

Notice how the green line (the 30 EMA) seems to be closer price than the violet line (the 30 SMA). This means that it more exactly represents current price action. You can perhaps guess why this happens. It’s mainly because of the exponential moving average places more importance on what has been trending lately. When trading, it is more important to see what traders are doing present days rather what they were doing last week or last month.

In this blog, I have only discussed few basics things about Technical Analysis. Please follow my future blogs for knowing more about technical analysis and how you can make a profit using this knowledge. My blogs on Relative Stock Index, Candle Stock Analysis are coming soon.....

Fundamental Analysis of Stocks

Fundamental Analysis – A Powerful Tool for Making Profit

You cannot invest in stock market blindly. Before investing your hard earned money to the stock market you should study the fundamental strength of those companies.

What is fundamental analysis?

Fundamental Analysis is a method, with this method you can evaluate the value of the underlying company. Basically, we do a fundamental analysis to understand the economic conditions and the industry along with the company’s financial condition and management performance. You can understand this by reading the balance sheet, the profit and loss statement, financial ratios and other data that could be used to forecast the future of a company. Generally, we use the real data to analysis a stock’s value. This method uses revenues, earnings, future growth, return on equity, profit margins and other data to define a company's underlying value and prospective for future growth.  The thinking behind the fundamental analysis is that as the company grows so will the value of the shares increase.

Fundamental Analysis Tools

Earnings Per Share

Earnings are profits. The most investors want to know about the earnings of the company before investing money in the company. Increasing earnings normally leads to a higher stock price and, in some cases, a regular dividend. Companies generally report about their earnings on a quarterly basis to their shareholders. Increasing earnings leads to a higher stock price and decreasing earnings leads to price fall of the shares. It works as an alarm. Factors defining earnings of the company are such as sales, costs, assets and liabilities. A basic view of the earnings is EPS (earnings per share). This figure of the earnings signifies the amount of earnings for each outstanding share.

Price to Earnings Ratio (PE Ratio)

Ratio analysis tool is the most commonly used tool in fundamental analysis. It is an indicator of the underlying value of a company in relation to the current share price and the reported earnings per share. It is calculated by dividing the current market price of an ordinary share by earnings per share.

The formula for calculating PE ratio:

PE Ratio =   Market Price per Equity Share                         

                         Earnings per Share

Example: The market price of XYZ Company’s share is Rs.500. And the earning per share is Rs.50. Then the PE ratio of that company will be 10. It refers the earnings per share of the company is covered 10 times by the market price of its share. Alternatively, you can say Rs.1 of earnings has a market value of Rs.10.

Now let’s understand how we can use PE ratio to analysis a stock

Suppose the market price of XYZ Ltd is Rs.600 and the earning per share is Rs.10. And the PE ratio of similar companies in the same industry is 8. It means the market value of XYZ limited should be Rs.800 (i.e., Rs.8 x Rs. 100). The market value of XYZ Limited is, therefore, undervalued by Rs.200. If the P/E ratio of similar companies is Rs.4, the market value of a share of XYZ Limited should have been Rs.400 (Rs.4 × Rs.100), thus the share is overvalued by Rs.200.

Price to Sales Ratio (PS Ratio)

Price to Sales ratio is another most popular fundamental analyzing tool.  Values below 1.0 often signal an undervalued company. A high PS ratio implies a high future revenue growth curve. Many stocks with high PS ratio have at least a few of quarters of demonstrated high revenue growth.

 

The formula for calculating PS Ratio

P/S Ratio = Price Per Share / Annual Net Sales Per Share

Let's assume company XYZ Ltd. reports net sales of 5,000,000 and it currently has 50,000 shares outstanding. The stock is currently trading at Rs.200.

Sales per share = 5,000,000/50,000 = 100

Price-to-Sales Ratio = 200/100 = 2

Now compare with company MNO Ltd.

MNO Ltd. reports net sales of Rs.5,000,000 and it also has 500,000 shares outstanding. The stock is trading at Rs.100.

Sales per share = 5,000,000/50,0000 = 10

Price-to-Sales Ratio = 100/10 = 10

Investors in MNO Ltd are willing to pay Rs.10 for Rs.1 in sales, while investors in XYZ Ltd are willing to only pay Rs.2 for Rs.1 in sales. MNO stocks are much more appealing here.

P/S ratio is suitable to use when valuing most types of stock. But note that P/S should never be the individual metric used when valuing a company.

Dividend Payout Ratio:

It works as an indicator of how the company is performing financially. The main motto of the companies is to maximize the wealth of the shareholders. When a company makes a profit then it becomes the duty of that company to pay dividends to their shareholders. When the profit is shared with their shareholders it is called dividend. And the percentage of the profit the company pays to their shareholders know as “dividend payout ratio”. 

Dividend Payout Ratio Calculation

Dividend Payout Ratio = Total Annual Dividends Per Share / Diluted Earnings Per Share

Let’s assume that Company X distributed four regular quarterly dividend payments of Rs.0.25 each, for a total annual dividend payment of Rs.1.00 per share. Over the same period, XYZ reported net earnings of Rs.10 per share. Company X dividend payout ratio is:

Rs.1 / Rs.10 = 10%

That means company X distributed 10% to the shareholders out of 100% as dividend and retains rest 90% as operating needs.

Dividend payout ratios offer valuable insight into a company's dividend policy.

Book Value:

Book Value is a key factor for measuring stock’s valuation. Book value means the total value of the company asset minus company's outstanding liabilities. Investors often look for the company’s book value. Investors find an opportunity to buy the shares when the shares traded below the book value.

Return on Equity:

It refers to how a company uses its valuable assets to produce earnings. This helps to evaluate the stocks.

ROE = Net Income / Book Value

A healthy company produces an ROE in the 14 to 15 percent range. You should not rely on this alone. Because a company might raise funds through borrowing fund rather than issuing stocks to the public. You need to consider at the ROE over a period of the past five years rather than just one year.

Always consider above all main fundamental tools for making investments in shares and get a healthy return on your investment.

Tips & Ideas for Investing in Shares without Taking Too Much Risk

Investing in stocks without taking too much risk is an art. I am going to share my experience on this blog with you.

Market Timing:

Buying and selling stocks at the right time is essential to successful investing. You have to wait for your turn when the market is in a downtrend and look for the buying opportunities. Always remember, don’t buy everything at once because your buying stock may come down further. For example, if you are thinking of buying 100 stocks of Reliance Industries when the market is in a downtrend, try to buy 25 stocks first and then if the market takes a downturn further then you can buy another 25 and so on. Alternatively, you can also buy 50 stocks first then 50 stocks later if the market comes down. So, spreading out of your initial investment over several months is a very important factor to minimize the risk. The same thing is applicable to selling stocks also.

Try to check the fundamental strength and technical chart of your selected stocks before buying the stocks. Reading technical chart is very important for timing in the stock market. Check if the stock trend is rising or declining. Stocks are moving forwards slowly can go further but if the stocks moving up rapidly, there is a high chance that it will level off or drop soon.

Check the trading volume of the trades. Trading volume is also very important in taking a decision. If the stock has more buyers, that's a good indicator of the stock's health. A rising price with a decreasing volume could mean that the price will fall soon due to lack of interest.

Always avoid volatile stocks, if the price of the stock jumps too much high, and you have noticed a lot of spikes in the technical chart. That means investing in these stock is not safe. Stay away from these stocks if you want to earn a profit without taking too much risk.

Diversify Your Investment to Minimize Risk:

Risk management is very important to achieve your investment goal. The investment in the stock market can give you a good return but if you are willing to do it with good risk management then it is best for you to learn about the diversification.  For example, if you are thinking to invest Rs.1,00,000, so with this amount you can select top 5 sectors and select 1 popular stock from each sector which will give you a higher return. You can then buy 5 stocks Rs.20000 each. In this process, you can get different ranges of returns without taking much risk. It is not a great idea to invest a massive amount in only one portfolio as if it will go in a loss, you will lose it all. 

The Timeframe is Key:

A long-term investment gives you a better chance of surviving any market storm - that's why I always say you should only invest for five years or longer if you are not willing to take a risk. If you buy and you’re your stocks repeatedly, much of your profit will go to commissions for brokers, and your gains will hurt. So, instead of buying and selling stocks frequently you should hold your stocks for a longer period of time. There is also a great chance of getting dividend frequently if you hold your stocks and you can reinvest them to increase your earning potential. Even investing before a huge market fall can also bring greater returns, provided your timeframe is long enough. 

Be Cautious about Buying Private Stock:

In reality, some companies keep their stock in private hands instead of trading their stock publicly on the stock market. Generally, these stocks are owned by a group of shareholders who can only sell their stock with approval from other shareholders. The shareholders set the price at which the stock can change hands. These stocks are very risky because you may not be able to buy or sell stock when you want to. You may have to make a large investment unless you are an employee of that company. OR it may even be a scam.

Start with Small:

This may sound very simple to you but it is also a very important factor if you are a new investor. You should start investing with a small amount in order to boost your confidence in the stock market. If you choose to invest a large amount to start you may not get a good return from the market. In that case, you may end up losing your hard earned money and confidence in the stock market. You need to gather more experience and knowledge if you want to earn a great return from the market. So starting with a small investment is always a great idea if you are a new investor. You can then start investing more as long as your experience and knowledge rises.

Don’t Monitor Your Investment too Closely:

If you want to invest to money for a long term in the stock market, then you do not need to monitor your investment frequently. Frequently monitoring your investment may distract you and force you to sell your stocks. You may end up with losing money. So, it is very important for you if you are expecting for good return without taking the risk.

Remember: The Bull market doesn’t last forever, and the main purpose of your portfolio is to allow you to live a more pleasing life. Your willingness and desires to take risk may not be as high as you think.

Things You Should Know About Initial Public Offer (IPO) Before Investing

Initial Public Offer popularly known as IPO is a process in which a company raises money by selling their shares to the public for the first time for growth and expansion. Investing in IPOs is very popular because it gives us the opportunity to earn quick money. And also if you are a long-term investor then you have been provided with the opportunity to buy some good companies shares at a cheap rate. If you are allotted shares in an IPO, you can then sell your stock in the secondary market. Secondary market means you can sell your shares on NSE or BSE (stock exchanges). Listing gains depend on demand and supply of that company shares. If the demand for a company’s shares very high then you will get high gain upon listing on the secondary market. But if the company’s shares are not in demand then it may be listed at a discount rate and you could suffer a loss.

Before investing in IPOs you must be very careful while selecting companies to invest in an IPO. 

Why should you invest in IPO?

You will get many benefits if you choose to invest in IPOs. Firstly, the companies normally offer discount price on the fair value when they are offering shares to the public for the first time. So that means as a retail client when you are buying IPOs, you are getting shares at a cheaper price. Secondly, there are many growing companies here in India, but they are still new to entering the stock market. So buying those companies’ shares in IPOs means you are associating with them from the beginning. Thirdly, it can be a gateway for you if you want to enter the stock market. You can get high return without taking too much risk. Also, not much of expertise is required for investing in IPOs, unlike stocks.

How to invest in an IPO?

If you have trading and Demat Account with any Stock Broker, that’s it now you can invest in an IPO. Research the company issuing IPOs before investing your money. Try to choose the best from the lot and check the issuing and closing date and pricing details of the IPO you want to invest. Your next step will be applying on the IPO. You cannot apply for any number of shares for an IPO like you can do with shares; you should be investing as per lot sizes according to the company specification. You may not be allocated all the stocks that you offer to buy. You may or may not be allocated a "pro rata" portion of the number of shares you have been offered to buy. Just try to request the maximum number of shares you would like to purchase assuming they are available. 

The main reasons behind companies go public:

• To Raise Fund:  The companies often offer IPO to the public to raise money. They generally use this raised fund for capital expenditure, working capital, research & development, and acquisitions and hoping for the company to grow and make more and more money for their shareholders.

• To build a reputation: Building reputation is very important for a company to sustain in the modern days.  Going public on reputable stock exchanges such as NSE or BSE Builds Company’s reputation because the company is now subject to the scrutiny of the SEBI (Securities and Exchange Board of India). As we all know the key to success is building a reputation. With better reputation, a company can attract higher talented employees, do business easier, and continue to raise money or cash out existing shareholders due to higher levels of trust.

• Marketing:  IPO is a great way for increasing prestige, new investors, and business partners.

You must know what you are investing in:

Any investors thinking of investing in IPOs need to do their homework first. This does not mean only checking the fundamentals of the company you are interested to invest but you should also know why the company is issuing IPO. Is the business plan of the company realistic? Is there any demand for the IPO issuing company’s products and services? The company belongs to which sector? Does the sector will perform well in the future? You can take advice from your financial advisor as well to gather the information related to the company.

Always check out the supporting cast of the IPO before Investing:

You have to understand the supporting cast of the IPO, without knowing it, you cannot judge the real value of an IPO. Firstly, you need to look at the promoter’s stake in the company post IPO. If the company is reducing the stake significantly, in that case, you won’t feel comfortable. Also, check out the pedigree of the bankers who invested and the book running lead managers.

There is continuously a lot of performance pressures associated with a public listed company, simply due to the fact that much info is made public within a very short period of time for the investors to guarantee timely decision making.

Understanding Futures and Options Trading

In this blog, I am going to discuss the basics of derivative market (Futures & Options). But before proceeding I would like to begin with few basic fundamental questions generally asked about futures and options.

What are Futures & Options (Derivative) Trading?

A derivative is a financial contract with a value that is derived from an underlying asset. An underlying asset is a security on which a derivative is based. Like stock trading in the cash, segment derivative is another kind of trading instrument. The derivative is mainly used to hedge the risk for one party of a contract. The more risk you undertake the more reward you can gain. The derivate traders who enter into a derivative contract are basically betting the future price of the underlying asset. Derivative trading is most popular among the companies who ensure profits in volatile markets.

To mitigate the risk everyday investors also look for derivative for their investment insurance.

An option is a contract between two parties in which the option buyer buys the right but not the obligation to buy or sell shares of an underlying stock at a predetermined price within a fixed period of time. Two types of stock options are available call and put options. Call options give the buyer the right to buy the underlying shares whereas put options provide the rights to sell them.

Strike price:

A strike price is set for each option by the seller of the option, who is also called the writer. When you buy a call option, the strike price is the price at which you can purchase the underlying asset if you select to use the option. For example, if you buy a call option with a strike price of Rs.100 then you have only the right, but not the obligation to buy the stock at Rs.100. You can also sell the call option to make a profit. Profit (the difference between the underlying stock price and the strike price). you can exercise your option and buy the stock at Rs.100.

Keep following my blogs to checks more detail about call & put options.

Futures vs. Options

Both futures and options are derivative instruments. Both derived from the underlying asset that they track. Both these options are a hot favourite for the speculators. Futures contracts have been primarily used by commodity traders such as crude oil, soybeans, wheat, coffee and so on. The futures contracts are more liquid than their option contract.

The most interesting part in options trading is that the risk is limited. You know here how much max you can lose here. For options contracts profit is unlimited but the loss is limited, unlike futures.

Although future trading has some significant advantages over options it is not suitable for everyone. Because futures contracts are leveraged they can be very risky, future trading is one of the most broadly widespread markets in the retail trading community.


 The derivative is the most popular trading instrument worldwide. The Futures and options segment also called F&O segments accounts for most trading across stock exchanges in India.

•To trade in futures the buyer or seller has to pay certain % of order value as margin. For example, if a trader wants to buy Reliance Industries may future 1 lot (500 units) at Rs.900. Then the buyer has to pay Rs.  4,50000 x 14% = Rs.63,000 for this trade. If the prices move up to 920 from 900 then the buyer get a profit of Rs. 10000. The percentage of profit will be 16%.

• Profits and losses are calculated on a daily basis as it’s is a margin trading until the trader buys or sells (square off) his position or the contract expires.

• The derivative has an expiry date. Three months contracts are always available. For example, right now there are 3 months future options are available. 1. April 2. May & 3. June. All contracts will expire on the last Thursday of that particular month. April contract is going to expire on 26th April, May on 31st and June on 28th. That means if you if enters in April contact then you have to square off your position by 26th April or on 26th April.

• The margin is calculated on a daily basis. You have to maintain proper margin in your account, otherwise, the broker will square off your position automatically.

• Future trading can be done on indices. Nifty future is the most popular traded future in India.

What is Hedging?

Hedging is the most important application of futures. Hedging mainly helps to protect the investors from making a loss by protecting their portfolio without selling off the stocks from the investors Demat account. Hedging is like transferring of risk without buying any insurance policy. Let’s imagine you have 4 or 5 stocks value Rs. 1,00,000 in your Demat Account and you are holding for long term. But you may worry about thinking that the market may come down but you don’t want to sell off your stocks. In this scenario, you can sell nifty future to protect yourself from the loss if the market comes down. Meanwhile, the position in the spot is ‘long’; we hedge for ‘short’ in the futures market. I will discuss hedging strategies in my future blog.

Return is always much higher in derivative trading than what you would make if you owned the stock.