So one fine morning, you wake up and decide to see what all your investments are. You are aghast and a little saddened to know that the Mutual fund that you have invested into has actually been giving negative returns and the paltry 8-9 % returns that your govt. bonds (such as the famous Kisan Vikas Patrika) and the fixed deposits are giving is nowhere close to the corpus you would be needing when you will propose to your girl. What do you do next? You think a lot and finally decide to invest (or play, that’s what we generally call investing in Stocks here in India) in stock markets. You call up that dude friends of yours who have been into stocks since you were roomies and he asks you to learn a bit about investing first before he could give you a list of hot stocks to invest in. He mumbles something about Alpha and Beta of a stock, returns, some analysis and stuffs and you do decide to find out what this hoopla is all about.
There are two kinds of analysis that is done on a stock: Fundamental Analysis and Technical Analysis. Fundamental analysis of any stock is done by using accounting principles and is concerned with estimating what the fair price of any stock is at a given point of time, using concepts such as book value, market form hypothesis, Greeks, volatility, time value of money and discounted cash flow. It estimates the price of any stock based on these parameters. I will be discussing these in detail in the next article on Fundamental Analysis.
The other kind of analysis, which is generally considered to be better than Fundamental Analysis, is technical analysis. In layman terms, it is a system of predicting the trend and movements of a stock based on its past volume and trend. Intuitively, this is what all of the stock traders do, be it on the Dalal Street or somebody like me, who invests every morning studying trends and predicting where the prices will move.
So, coming back to you. You decide to do what every stock investor does: You start to study the past trends of a stock, say X, and go to some online sites and start tracking it. Most probably you will encounter a graph like the one shown below.
You start observing how it has done in the past, say one week, one month, a year and so on and start seeing some trends in the graph, since this is the format in which most of the sites will show you the data and suddenly, without any previous knowledge of stocks, you will start thinking and formulating in your mind, how it might behave in the coming days. This, my friend, is what we call Technical Analysis!
So, you see that this particular stock has been very volatile in the last 7-8 months, with spikes (what we call high) and troughs (what we call lows) alternating very frequently. You also see that past 4 months have been kind of bad, in fact very bad for the investors. You also start thinking of the returns that you might have got if you have invested over a particular time or on a particular date. You might also think of the average return that you might have got had you invested over some period and the like.
There are various parameters used in technical analysis, various kinds of averages such as moving average which is nothing but a graph plotted for the closing price of a stock averaged over last n days. Candle graphs are used to show the prices, bar graph and volume line are also used for the same purpose. Be it any representation, I hope you have got an idea what technical analysis is. In the next article in the series, I will be taking up some basic terminologies and fundamental analysis.
Happy Investing!
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