MODULE 3

Fundamental analysis is a method used to evaluate the intrinsic value of a security by

examining various economic, industry-specific, and company-level factors. This analytical
approach provides insights into whether a security is undervalued, overvalued, or fairly priced,
assisting investors in making informed long-term investment decisions. Fundamental analysis
involves three key components: Economic Analysis, Industry Analysis, and Company
Analysis.
1. Economic Analysis
Economic analysis forms the foundation of fundamental analysis by assessing the
macroeconomic environment. It examines factors that influence industries and companies, such
as growth prospects, policy decisions, and global economic trends.
Key Components of Economic Analysis
1. Gross Domestic Product (GDP)
GDP indicates the overall health of an economy by measuring its output. A growing
GDP reflects economic expansion, fostering a favorable business environment, while a
contracting GDP suggests recessionary pressures.
2. Inflation
Inflation measures the rate at which prices increase over time. Moderate inflation
signals stable demand, but high inflation can reduce purchasing power and increase
costs for businesses. Deflation, on the other hand, can lead to lower revenues due to
reduced consumer spending.
3. Interest Rates
Central banks regulate interest rates to control economic activity. Lower interest rates
reduce borrowing costs, encouraging investments and consumption, while higher rates
may slow down economic growth.
4. Employment Levels
Low unemployment rates indicate a robust economy with higher consumer spending,
while high unemployment rates signal weak economic activity, negatively impacting
industries.
5. Fiscal and Monetary Policies
Fiscal policies like government spending and taxation, along with central bank actions
such as rate adjustments and liquidity management, significantly impact the economy.
6. Global Trade and Exchange Rates
International trade policies and currency exchange rates affect export-driven industries.
A strong domestic currency can hinder export competitiveness, while a weak currency
may boost exports.
Purpose of Economic Analysis
Economic analysis helps investors understand the broader market conditions and identify
industries poised to benefit from favorable economic trends. For instance, a period of economic
expansion may favor cyclical industries like automobiles and construction.
2. Industry Analysis
Industry analysis focuses on understanding the dynamics, challenges, and opportunities within
a specific sector. It provides insights into an industry’s growth potential and its competitive
landscape.
Key Components of Industry Analysis
1. Industry Growth Rate
Evaluating historical and projected growth rates helps investors identify industries with
promising prospects, such as renewable energy or e-commerce.
2. Market Structure
Industries can be classified as monopolistic, oligopolistic, or competitive. Monopolies
and oligopolies generally have higher profitability due to less competition, while
competitive markets may face pricing pressures.
3. Demand-Supply Dynamics
Understanding the demand-supply balance helps assess potential revenue growth. For
example, rising demand for electric vehicles indicates strong prospects for the
automotive battery sector.
4. Technological Innovations
Technological advancements can disrupt traditional industries and create opportunities
for new players. Companies embracing innovation often gain a competitive edge.
5. Regulatory Environment
Industry-specific regulations, environmental norms, and trade policies significantly
influence operations. For example, stringent emission norms have led to increased
investments in green technologies in the automobile industry.
6. Competitive Landscape
Porter’s Five Forces framework evaluates industry competition:
o Threat of New Entrants: Barriers to entry protect established players.
o Bargaining Power of Suppliers: High supplier power can squeeze profit
margins.
o Bargaining Power of Buyers: Buyers' ability to demand lower prices affects
profitability.
o Threat of Substitutes: Availability of alternative products limits pricing power.
 o Industry Rivalry: Intense competition can reduce market share and profits.
Purpose of Industry Analysis
Industry analysis identifies sectors with favorable conditions and highlights risks associated
with others. For example, a growing technology sector might indicate opportunities for
semiconductor manufacturers.
3. Company Analysis
Company analysis delves into the financial health, operational efficiency, and strategic
positioning of individual businesses. It combines quantitative metrics with qualitative insights
to determine a company’s intrinsic value.
Quantitative Analysis
1. Financial Statements
o Income Statement: Provides insights into revenue, expenses, and profitability.
Metrics like gross profit margin and net profit margin assess operational
efficiency.
o Balance Sheet: Highlights the company’s financial structure by examining
assets, liabilities, and equity.
o Cash Flow Statement: Evaluates cash inflows and outflows from operations,
investments, and financing activities to assess liquidity and sustainability.
2. Financial Ratios
o Liquidity Ratios: Assess a company’s ability to meet short-term obligations
(e.g., Current Ratio, Quick Ratio).
o Profitability Ratios: Measure how effectively a company generates profit (e.g.,
Return on Equity, Net Profit Margin).
o Valuation Ratios: Compare a company’s market price to its financial metrics
(e.g., Price-to-Earnings (P/E), Price-to-Book (P/B)).
3. Historical Performance and Valuation Models
o Analyzing past performance trends provides insights into consistency and
growth.
o Valuation models like Discounted Cash Flow (DCF) and Dividend Discount
Model (DDM) estimate the company’s intrinsic value.
Qualitative Analysis
1. Management Quality
A strong and experienced management team with a clear vision is critical for long-term
success. Examining leadership track records and decision-making provides insights into
governance.
2. Business Model
 Understanding how the company generates revenue and sustains profitability is
essential. Scalable and innovative business models often have a higher growth
potential.
3. Competitive Advantage
A company with a strong market position, unique products, or brand strength can
sustain competitive advantages over time.
4. Corporate Governance and Ethics
Transparent governance and ethical practices enhance investor confidence and reduce
risks associated with scandals or mismanagement.
5. SWOT Analysis
Conducting a Strengths, Weaknesses, Opportunities, and Threats analysis provides a
holistic view of internal and external factors influencing the company.
Purpose of Company Analysis
Company analysis helps investors identify businesses with strong fundamentals, sustainable
growth prospects, and reasonable valuations. For instance, a company with a robust financial
position, innovative products, and an expanding market share is likely a good investment.

Meaning of Technical Analysis

Technical Analysis is a method used to evaluate securities and make trading decisions by
analyzing statistical trends gathered from trading activity, such as price movements and
volume. Unlike fundamental analysis, which focuses on the intrinsic value of a security,
technical analysis is solely concerned with historical data to predict future price movements.
Key Principles of Technical Analysis
1. Market Discounts Everything
Technical analysts believe that all information—economic, political, or financial—is
already reflected in the price of a security. Therefore, analyzing price movements is
sufficient to predict future trends.
2. Prices Move in Trends
Price movements follow identifiable patterns or trends (uptrend, downtrend, or
sideways), which tend to persist until a significant event changes the trend.
3. History Tends to Repeat Itself
Patterns observed in the past are likely to recur, as they are driven by market psychology
and human behavior, which remain consistent over time.
Objectives of Technical Analysis
 To identify buying and selling opportunities by analyzing price charts and indicators.
 To determine the direction and strength of trends in the market.
 To manage risk and timing of trades effectively.

Differences Between Fundamental Analysis and Technical Analysis

Aspect Fundamental Analysis Technical Analysis

Evaluates a security's intrinsic
Analyzes past price movements and
1. Definition value based on economic, financial,
volume to predict future price trends.
and qualitative factors.
Focuses on the underlying value of Focuses on market price and trading
2. Focus
the company or asset. patterns.
Short- to medium-term, timing-
3. Approach Long-term, value-based approach.
based approach.
Identifies undervalued or
Determines the right time to buy or
4. Objective overvalued securities for long-term
sell a security.
investment.
Economic conditions, industry Price charts, volume data,
5. Key Factors
trends, company financials, and support/resistance levels, and
Analyzed
management quality. technical indicators.
Financial statements, ratios, Charts, moving averages, RSI,
6. Tools Used valuation models, economic MACD, candlestick patterns,
indicators. Fibonacci retracements.
Focuses on long-term performance Focuses on short-term price
7. Time Frame
and growth potential. movements and market timing.
Believes prices may not always
8. Market Assumes that all market information
reflect the intrinsic value of the
Assumptions is already reflected in the price.
security.
Not reliant on trends; evaluates true
9. Dependency Strongly reliant on market trends
value irrespective of market
on Trends and historical patterns.
sentiment.
Investors seeking long-term Traders aiming for short-term gains
10. Suitable For
investment opportunities. or market timing.
Qualitative and quantitative
11. Nature of Quantitative (charts, patterns, and
(economic, industry, and company
Analysis indicators).
factors).
Focuses on reducing long-term risk
Focuses on managing short-term
12. Risk Focus by investing in fundamentally
market risks and volatility.
strong assets.
 Dow Theory
The Dow Theory is one of the foundational principles of technical analysis, introduced by
Charles H. Dow. It provides a framework for understanding how markets behave and
identifying potential trends. Dow Theory focuses on the movement of stock prices to analyze
market trends and predict future price movements.
Key Principles of Dow Theory
1. The Market Discounts Everything
The stock market reflects all available information (economic, political, or company-
specific) in the prices of securities. Changes in price represent the collective judgment
of all market participants.
2. The Market Has Three Trends
o Primary Trend: The main trend lasting from several months to years, reflecting
the market's overall direction (bullish or bearish).
o Secondary Trend: Short-term corrections or rallies within the primary trend,
typically lasting weeks to months.
o Minor Trend: Daily fluctuations that may last days or weeks and are considered
noise in the larger trends.
3. Trends Have Three Phases
o Accumulation Phase: Informed investors start buying (in a bull market) or
selling (in a bear market) quietly, as public sentiment is pessimistic or overly
optimistic.
o Public Participation Phase: More investors join as the trend becomes evident;
this phase sees significant price movements.
o Excess Phase: Speculation dominates, and the trend reaches its peak or trough,
often leading to a reversal.
4. Indices Must Confirm Each Other
For a trend to be validated, multiple indices (e.g., Dow Jones Industrial Average and
Dow Jones Transportation Average) must move in the same direction. If one index
moves upward while the other declines, it signals uncertainty.
5. Volume Confirms the Trend
Volume should increase in the direction of the trend. In a bull market, volume rises
during price increases and decreases during pullbacks. Conversely, in a bear market,
volume increases during price declines and decreases during rallies.
6. Trends Continue Until a Clear Reversal Occurs
A trend remains in place until there are clear signals of reversal. This principle
emphasizes the importance of not acting against the prevailing trend prematurely.
Importance of Dow Theory
 Identifies Long-Term Trends: Helps traders and investors align their strategies with
the primary trend.
 Basis for Modern Technical Analysis: Dow Theory introduced concepts like trends,
confirmation, and volume analysis, forming the foundation of modern technical tools.
 Risk Management: Assists in identifying market reversals and minimizing risk by
avoiding trades against the trend.

Advances and Declines in Dow Theory

Advances and Declines refer to the number of stocks that rise (advance) or fall (decline) in
price during a specific trading period. These metrics help gauge the breadth of the market,
which is an essential concept in Dow Theory for analyzing market trends and confirming their
strength.
Advances
 Definition:
Advances are the total number of stocks whose prices have increased compared to
their previous closing prices during a trading session.
 Significance:
A large number of advances indicates strong bullish sentiment and widespread
participation in a rising market trend.
Declines
 Definition:
Declines are the total number of stocks whose prices have decreased compared to
their previous closing prices during a trading session.
  Significance:
A high number of declines suggests bearish sentiment and broad-based market
weakness.
Role of Advances and Declines in Dow Theory
1. Market Breadth Analysis:
o Market breadth measures how broadly the market's trend is supported by
individual stocks.
o If an index rises but the number of declining stocks exceeds advancing stocks,
it indicates weak market breadth and a potential divergence from the trend.
2. Trend Confirmation:
o In a bull market, advances should consistently outnumber declines, reflecting
broad participation in the upward trend.
o In a bear market, declines should dominate, signaling broad participation in
the downward trend.
3. Divergences:
o When an index moves upward but declines outnumber advances, it suggests a
weakening trend.
o Conversely, if the index moves downward but advances outpace declines, it
may indicate a potential reversal.
4. Volume Analysis:
o Advances and declines are often analyzed alongside trading volume. For
example:
 High volume on advances signals strong buying pressure.
 High volume on declines indicates strong selling pressure.
Importance of Advances and Declines
 Identifying Reversals: Divergences between advances/declines and market indices
can signal a potential market reversal.
 Evaluating Trend Strength: Strong trends are supported by a large number of
advancing stocks in a bull market or declining stocks in a bear market.
 Measuring Market Sentiment: Advances and declines provide insights into the
overall mood and participation in the market.
Example
 Bullish Market:
o Index rises, 70% of stocks advance, and the A/D line trends upward.
o Confirms strong bullish market breadth.
  Bearish Market:
o Index falls, 60% of stocks decline, and the A/D line trends downward.
o Confirms strong bearish market breadth.
 Divergence:
o Index rises, but declines outnumber advances.
o Indicates weak market participation and a potential reversal.

Explaining Common Types of Charts

Charts are essential tools in technical analysis used to visualize historical price movements
and predict future trends. Each chart type presents data in a unique way, suited for specific
purposes. Below are the details of Line Chart, Bar Chart, Candlestick Chart, and Point &
Figure Chart.
1. Line Chart
Description:
 The line chart is the simplest form of chart representation.
 It connects the closing prices of a security over a specified time frame with a
continuous line.
Key Features:
 Displays only the closing price for each time period (daily, weekly, etc.).
 Focuses on the overall trend by ignoring price fluctuations during the trading period.
Advantages:
 Easy to read and understand for beginners.
 Highlights long-term trends clearly.
Disadvantages:
 Omits detailed information like opening price, highs, lows, or intraday movements.
 Less useful for short-term analysis.
2. Bar Chart
Description:
 A bar chart represents price movements using vertical bars.
 Each bar contains four key pieces of information:
o Open: Opening price of the time period.
o High: Highest price during the time period.
o Low: Lowest price during the time period.
o Close: Closing price of the time period.
Key Features:
 A vertical line shows the range between the high and low prices.
 A horizontal tick on the left side represents the opening price.
 A horizontal tick on the right side represents the closing price.
Advantages:
 Provides detailed information about price movements.
 Useful for identifying trends, price gaps, and reversals.
Disadvantages:
 More complex to interpret compared to a line chart.
 Visual clutter can occur when analyzing many data points.
3. Candlestick Chart
Description:
 The candlestick chart is similar to a bar chart but uses a more visual and colorful
representation.
 Each candlestick shows the open, high, low, and close prices for a given time period.
Key Features:
 A candlestick has two parts:
o Body: Represents the range between the opening and closing prices.
 Green/White Body: Closing price is higher than the opening price
(bullish candle).
 Red/Black Body: Closing price is lower than the opening price
(bearish candle).
o Wicks/Shadow: The vertical lines above and below the body represent the
high and low prices.
Advantages:
 Highly visual, making it easier to interpret trends and market sentiment.
 Candlestick patterns (e.g., Doji, Hammer, Engulfing) provide insights into potential
reversals or continuations.
Disadvantages:
 Requires familiarity with candlestick patterns for effective use.
 May include unnecessary details for long-term analysis.
4. Point & Figure Chart
Description:
 A point & figure chart plots price movements using X's (for rising prices) and O's
(for falling prices), focusing purely on price changes, ignoring time and volume.
Key Features:
 A new X or O is added only when the price moves by a specified amount (called the
box size).
 Time is not a factor; the chart updates only when price changes exceed the box size.
 Emphasizes significant price movements and trends while filtering out noise.
Advantages:
 Removes minor price fluctuations and noise, focusing on meaningful trends.
 Simplifies the identification of support, resistance, and breakout levels.
  Ideal for identifying long-term trends.
Disadvantages:
 Does not provide detailed intraday price information.
 May not be intuitive for beginners unfamiliar with the concept.

Comparison of Charts

Chart Type Data Represented Strengths Weaknesses

Closing prices over Simple and clear; long- Lacks detailed price
Line Chart
time term trends data

Open, High, Low, Detailed analysis;

Bar Chart More complex to read
Close (OHLC) shows price range

Candlestick Open, High, Low, Highly visual; patterns Requires knowledge of

Chart Close (OHLC) for reversals patterns

Point & Figure Price movements Focuses on significant Time element and
Chart (ignores time) price changes volume excluded

Chart Patterns in Technical Analysis

Chart patterns are visual formations on price charts that provide clues about the future
movement of prices. They help traders identify potential reversals or continuation of trends.
Below is a detailed explanation of key patterns such as Head and Shoulders, Triangles,
Rectangles, Flags, Double Top, and Double Bottom.
1. Head and Shoulders
Type: Reversal Pattern
Description:
 The Head and Shoulders pattern signals a reversal of a bullish trend into a bearish
trend.
 It consists of three peaks:
o Left Shoulder: A smaller peak followed by a decline.
o Head: A higher peak in the middle.
o Right Shoulder: Another smaller peak similar to the left shoulder.
Key Features:
 The neckline connects the lows between the peaks.
 A break below the neckline confirms the bearish reversal.
Inverse Head and Shoulders:
 A bullish reversal pattern where the formation is inverted, signaling the reversal of a
bearish trend into a bullish trend.
Implications:
 After the neckline is broken, the price is likely to move downward (in the regular
pattern) or upward (in the inverse pattern).

2. Triangles
Type: Continuation or Reversal Pattern
Description:
Triangles represent periods of consolidation and are categorized based on the direction of the
trendlines.
1. Symmetrical Triangle:
o Two converging trendlines, one descending and one ascending.
o Indicates indecision; a breakout could occur in either direction.
2. Ascending Triangle:
o A flat upper trendline and a rising lower trendline.
o Typically bullish; breakout occurs above the resistance level.
3. Descending Triangle:
o A flat lower trendline and a descending upper trendline.
o Typically bearish; breakout occurs below the support level.
Implications:
 Breakouts from triangles usually result in strong price movements in the breakout
direction.

3. Rectangle
Type: Continuation or Reversal Pattern
Description:
 The Rectangle pattern occurs when the price moves within a horizontal range,
creating a box-like shape.
  It forms between parallel support and resistance levels.
Key Features:
 Breakout above the resistance signals a bullish continuation or reversal.
 Breakdown below the support signals a bearish continuation or reversal.
Implications:
 Rectangles indicate a period of consolidation before the price breaks out in the
direction of the prevailing trend.
4. Flag
Type: Continuation Pattern
Description:
 The Flag pattern forms after a sharp price movement (called the flagpole), followed
by a period of consolidation in the form of a small rectangular pattern.
 Flags can tilt upward, downward, or sideways.
Key Features:
 Bullish Flag: Forms during an uptrend; the breakout occurs upward.
 Bearish Flag: Forms during a downtrend; the breakout occurs downward.
Implications:
 The price usually continues in the direction of the initial trend after the breakout.

5. Double Top
Type: Reversal Pattern
Description:
 The Double Top pattern signals a bearish reversal.
 It forms two peaks at nearly the same price level, separated by a trough.
Key Features:
 The neckline is drawn through the low between the two peaks.
 A break below the neckline confirms the pattern.
Implications:
  After breaking the neckline, the price is expected to decline sharply.

6. Double Bottom
Type: Reversal Pattern
Description:
 The Double Bottom pattern signals a bullish reversal.
 It forms two troughs at nearly the same price level, separated by a peak.
Key Features:
 The neckline is drawn through the high between the two troughs.
 A breakout above the neckline confirms the pattern.
Implications:
 After breaking the neckline, the price is expected to rise significantly.

Comparison of Patterns

Pattern Type Indication Key Features

Signals trend reversal

Head and Three peaks with a
Reversal (bullish to bearish or vice
Shoulders neckline.
versa).

Converging trendlines
Indicates consolidation
Triangles Continuation/Reversal (symmetrical, ascending,
with a potential breakout.
or descending).

Suggests a period of
Horizontal support and
Rectangle Continuation/Reversal sideways movement
resistance levels.
before a breakout.

Suggests a brief
Flagpole followed by a
Flag Continuation consolidation before
small rectangular pattern.
continuing the trend.
Pattern Type Indication Key Features

Signals a bearish trend Two peaks with a neckline

Double Top Reversal
reversal. below.

Double Signals a bullish trend Two troughs with a

Reversal
Bottom reversal. neckline above.

Moving Average
A Moving Average (MA) is one of the most widely used technical analysis tools in trading. It
is a statistical calculation that smooths out past price data by creating an average price over a
specific period. This helps to reduce the "noise" caused by short-term fluctuations in price and
makes trends easier to identify.
Features of Moving Averages
1. Smoothing Effect:
Moving averages smooth out price data to help identify the direction of the trend by
filtering out price noise or short-term fluctuations.
2. Lagging Indicator:
Since moving averages are based on past prices, they are considered lagging indicators,
meaning they react to price movements rather than predict future price action.
3. Customizable Periods:
The time period for a moving average can be adjusted depending on the trader's strategy.
Shorter periods (e.g., 10-day MA) react quickly to price changes, while longer periods
(e.g., 200-day MA) provide a more stable trend analysis.
4. Crossovers:
One of the most commonly used strategies involves moving average crossovers. When
a shorter-period moving average crosses above a longer-period moving average, it
signals a potential buying opportunity (bullish crossover). Conversely, when the
shorter-period moving average crosses below the longer-period moving average, it
signals a potential selling opportunity (bearish crossover).
5. Support and Resistance:
Moving averages often act as dynamic support or resistance levels. In an uptrend, prices
may bounce off the moving average (support), and in a downtrend, prices may face
resistance at the moving average.
Importance of Moving Averages
1. Trend Identification:
Moving averages are crucial for identifying the direction of the trend. When the price
is above a moving average, the market is considered to be in an uptrend, and when the
price is below the moving average, it indicates a downtrend.
2. Smoothing Volatility:
By averaging out fluctuations in price, moving averages provide a clearer picture of the
market's trend and eliminate random short-term price movements that can lead to false
signals.
3. Signal Generation:
Moving averages can generate buy or sell signals through crossovers. When a short-
term MA crosses above a long-term MA, it may indicate a bullish trend, and vice versa
for bearish trends.
4. Support and Resistance Levels:
Moving averages often act as dynamic levels of support or resistance. Traders use this
to set stop-loss orders or target prices.
Objectives of Moving Averages
1. Trend Detection:
The primary objective of moving averages is to help traders detect the underlying trend
in the market. They smooth out price data and make it easier to see the direction of the
trend.
2. Smoothing Price Action:
Moving averages eliminate short-term price volatility and noise, providing a clearer
picture of the market's direction over a longer period.
3. Generate Trading Signals:
Moving averages, particularly crossovers, are used to generate buy and sell signals.
Traders use the crossing of shorter-period MAs over longer-period MAs as an indicator
of potential market moves.
4. Provide Support and Resistance Levels:
Moving averages are used to identify potential support and resistance levels. Prices tend
to bounce off moving averages in trending markets, and these levels can be used for
entry and exit points.
5. Market Confirmation:
Traders use moving averages to confirm trends. When a stock is trending in the same
direction as the moving average, it reinforces the strength of the trend.