Fundamentals analysis says best way to predict future trends of a stock is to understand financial figures of underlying company. The fundamental analyst would calculate a theoretical value of company using cash flow analysis, recent dividends and earnings, future dividends and earnings projections plus a host of other economic numbers. If current stock price is lower than calculated value, a trader who uses fundamental analysis would buy this stock.
This writer has opinion that fundamental analysis is difficult to master for it to be useful as a forecasting tool. Understanding and analyzing balance sheets and profit and loss accounts is not enough. You will need to analyze micro and macroeconomic picture as well. Often you will need to be have same knowledge equivalent to senior-management of a company you want to analyze – minus leadership and management skills.
Take example of Google’s free 2 GB e-mail service. How much does it cost them? Probably about $2 yearly for each customer. Assuming 100 million internet users sign up, advertising revenues from this segment alone would provide a tidy profit. It is analyst job to provide a good educated-guess of this number. More importantly, this new signings will provide a customer base to challenge Yahoo and Microsoft. With Google’s dominance in search engine market, data mining of such a huge pool of internet users will provide them with an edge in deciding future strategies over its two nearest rivals. Try translating this to what can Google earn in next two quarters.
One of better tools is Z-Score, developed by Edward Altman, a financial economist and professor at New York University's Stern School of Business, in 1968 to predict corporate bankruptcies within a two-year period. This formula has a 70-plus percent accuracy rate
Technical analysis. The “price action discounts everything” premise is central to charting, also known as technical analysis. Technical analysis uses graphic representations for prices and makes uses of various quantitative techniques to forecast price trends.
A technician makes profits in any market by having positions in line with price trend. When trend is up, then buy. Conversely, when trend is down, then look to sell. Technical analysis is not an exact science, but it is easy to learn and effective.
Technical analysis is a good starting point for beginners. The foundation should include classical technical analysis, Japanese candlesticks, trendlines, RSI, MACD, ADX, stochastics and moving averages. Learners can complete these core topics within three to six months. With constant practice, you should be able to independently analyze and identify current trends in stock market.
Most users of stock charts may only focus on daily charts. However, if users pay equal attention to weekly as well as monthly charts, picture is intuitively more complete. This is equivalent to understanding how short, medium and long-term investors are viewing markets, after all three main types of investors form market. A handful of stock charting software has this feature of showing say, relative strength index for daily, weekly and monthly values on a single screen.