How to Analyze a Stock
There are two ways that investors and traders will analyze a stock before purchasing or selling shares. These are called technical and fundamental analysis. While most people that trade stocks use both to make decisions, there are still quite a few investors that focus on one or the other. We will discuss both and cover which one will likely be more important based on the type of stock trader you would like to become.
Technical analysis is all about the chart. Lesson two discussed the common stock chart that shows the price of a stock on one axis and a period of time on the other. At its simplest form, technical analysis is an attempt to discover a pattern in the price of a stock that will help predict future prices of that same stock.
Here is an easy example of what we mean when we say pattern.
This chart shows the price of Lanett Company Inc.(LCI), a generic drug maker with incredible growth. The chart shows the price each day for 2 years, shown in the light blue color. The maroon lines are drawn to help show what we mean when we talk about patterns. As you can see, when the price of LCI hits that maroon line, or somewhat close to it, the price then has a tendency to begin climbing (called a bounce), and usually eventually climbs to the top maroon line. When the stock price hits the upper maroon line, it has a tendency to fall pretty quick. As you can see in the graph, this has happened 3-4 times. Clearly a pattern has been established.
Recall in previous lessons that talked about the concept of purchasing a stock while it is at a low price in order to sell it when it is at a high price. LCI is a great example of a simple technical analysis pattern called a channel. If you are an active stock trader you would purchase the stock when the price is close to the maroon line on bottom, and sell it when it gets close to the maroon line on top.
It is important to note that the maroon lines do not come drawn on charts. An investor must try out different time frames and look for different patterns that may arise. Lots of patterns require more information than just the price and the time. They use how many shares were traded in a given day, and plenty of other available information to discover and utilize patterns. Beginning stock trader teaches dozens of chart patterns to look for on the technical trading strategies page.
You can also check out our technical analysis books page to find advice on technical analysis from some of the best investors in the game.
Fundamental analysis is more familiar to most people that are just beginning to trade stocks. This form of analysis involves looking at the fundamentals of a stock; for example how much money the company made, how fast it is growing, how much cash it has in reserves, how much debt it has on its books, and much more. While the goal of technical analysis is to determine a good time to buy and sell a stock, regardless of whether or not the company is succeeding or failing, the goal of fundamental analysis is to determine how successful a company is, and more importantly how successful it will be in the long-term. Most of this information is available through your broker.
The first thing to know is where to find fundamental information about a company you would like to invest in. Luckily, due to regulations from the SEC, all publicly traded companies are required to issue quarterly reports. These reports are filled with important information for investors on how the company did financially in the past three months, and often where they plan to be in the months to come. Most brokers have easy access to these reports, accessible to all account holders.
Some of the most important things these quarterly reports contain are revenues and profits. With these two numbers it is possible for an investor to go back and look at previous reports and see if the company is growing revenue, meaning they are making more each year and likely growing as a company. Traders can also look at the profit and determine if the company is actually profiting from their revenues, or if their operating costs are wiping out all potential profits.
In addition to quarterly reports, companies are required to release big news at the same time to everyone so that everyone has a fair shot at buying their stock. Three of the most important documents to understand are the 10-k, the 10-q and the 8-k. All of these contain important information for investors to determine how much a share of stock in the company should be worth. Click any of the links in this section to learn more about the specified form and see examples.
Want to learn more about fundamental analysis? Check out our market courses page for full length courses.