When you begin investing, you enter a strange
new world of language and terms. Each one can
help you invest with more confidence and more
likelihood of success. Read this chapter and then
use it as a resource guide. Come back to it again and
again to refresh your memory until the information
becomes second nature to you.
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All public companies need to issue annual reports.
While some companies may engage in ‘creative
accounting’, the numbers that must be reported
can help you see how a company is performing.
Is it growing or shrinking sales from year to
year? Is it taking on more debt? Is it increasing or
decreasing in value? How risky is a company? All
this information is can be uncovered as you look
at the numbers the company reports.
When you go to any securities market page, you are
likely to find a list of abbreviations and numbers.
Making sense of these numbers allows you to
invest wisely. Once you know about them, it’s easier
to choose instruments with a higher probability of
rising.
4.1 Fundamental Analysis
Fundamental Cheat Sheet
Fundamental Definition
Investors typically believe
the numbers indicate
Beta
measures
volatility
lower number = lower risk
Dividend
Ratio
Dividends/
earnings
higher number =
increased dividend payout
Debt Ratio
total debt / total
assets
Lower (below 1) stronger
company
EBITDA company’s ROI
Lower number = cheaper
valuation
EV Enterprise
Value
Total assets of
company
Higher number = larger
company
EV/EBITDA
Best measure of
company value
Lower number = better
valuation
EPS
Earnings per
share
Higher number = more
profit
PE Ratio
Price to earnings.
Quick company
assessment.
Lower number = better
valuation
Market Cap Size of company
Large number = bigger
company
Volume
Number of shares
traded
Large number = more
trading interest
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52 Week Range lets you see how the instrument
has traded over the past year. You can compare
the current price to the high and low. The chart will
show you the trend, either up, down, or sideways.
If it’s coming off lows, it may be undervalued.
Beta tells you the volatility of a security. A Beta of
1 is average, so a fraction below that means it is
less volatile than the overall market. A higher Beta
shows the price uctuates more than average. A
Beta of 1.2 means the security can be 20% more
volatile than average. Traders like the increased
volatility because it opens up more trades. It can
also be an indication of the degree of risk you take
on.
Debt Ratio shows how well a company can pay off
its debts with its current assets. It’s found by dividing
the total liabilities by the total assets. While debt
ratios vary by sector, a number of .5 is a reasonable
debt load. A debt ratio of 1.0 tells you the company
would need to sell all its assets to resolve the debt.
Cheap interest has encouraged many companies
to borrow to buy back stock. This makes their price
to earnings, or PE, ratio look good. Don’t be fooled.
The more secure EV/EBITDA ratio will still reect
the debt.
Highly leveraged or indebted companies may not be
able to raise cash in a crisis or a downturn making
them more risky.
Dividend Ratio is the percentage of earnings paid
to stockholders. It’s found by dividing the dividend
per share with the earnings per share (EPS). If they
are the same, the number would be 1. If a company
retains 50% of their earnings to fund growth, the
number would be a .5. At times some companies
choose not to cut their dividends, so they may
pay out more than they earned. In this case the
dividend ratio would be higher than one, say 1.3.
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This higher rate is not sustainable for long. Either
the company must increase earnings or cut
dividends. Be cautious of a company paying large
dividends with a ratio significantly above 1
EBITDA means earnings before interest, taxes,
depreciation and amortization. This measure
shows net income after expenses. It’s used to
measure a company’s cash return on investment
or ROI.
Enterprise Value (EV) might be considered the
takeover price of the company. To calculate the
EV, start with total cash and cash equivalents. Then
subtract the liabilities of debt, outstanding shares of
stock, minority interest, and preferred shares. The
less debt a company has, the higher its Enterprise
Value is likely to be. But watch out for hidden debt
like unfunded pension liabilities, leasing obligations,
or other guaranteed payments. This gives you a
sense of what the company is worth.
EV/EBITDA may be the most accurate reading
of a company’s value. It’s more complete than a
simple price to earnings ratio that does not include
company debt.
The EV/EBITDA is printed as a fractional percent. For
example in the first quarter of 2017, Apple (APPL)
had an EV/EBITDA of 10.60 The average ratio is
11.4. Ideally, the lower the number, the cheaper the
valuation. Trading stocks with a low EV/EBITA ratio
has been shown to lead to more profitable returns
than trading based on a P/E ratio alone.
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Find the EV/EBITDA Value
Enterprise Value .
Earnings before interest, taxes,
depreciation and amortization
EPS means Earnings per Share. This indicates how
profitable a company may be. It takes
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Gula, Alan, ‘A Superior Metric for Value Investors’ Wall St. Daily, 6 Jun 2014 https://www.wallstreetdaily.com/2014/06/06/ev-ebitda-valuation-metric/
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profitable a company may be. It takes the net
income from a company (minus the dividends paid)
and divides that by the number of outstanding
shares. Large sales of equipment, a division, or
one-time losses (like settling a lawsuit) might be
included or excluded to give a more favourable
number. Cash EPS is operating cash ow divided
by outstanding diluted shares (all shares possible,
including stock options). Operating cash can’t be
manipulated so this EPS gives a better indication
of the profitability of the company. EPS can be
calculated on past numbers using Trailing Twelve
Months (TTM) or on forward looking data.
Market Cap is sometimes called market
capitalization. It is the total value of all the
outstanding shares of a company. It is not
necessarily the actual value of the company or its
assets. Investors use market cap to determine the
size of the company. Large-cap companies are
over $10 billion and are usually established, major
players. Mid-cap companies are $2-$10 billion
and often offer more rapid growth accompanied
by increased risk. Small-cap companies are $300
million to $2 billion. They may be early-stage
companies or serve a niche market. Since they
have fewer resources they often have a higher
risk.
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PE Ratio is the price to earnings ratio. The lower
the PE, the more value you are getting. It compares
the current price of a share to the company’s
earnings per share.
The PE shows the price investors are willing to pay
per pound of the company’s earnings. If the PE
Ratio was 42.5 they would be willing to pay £42.50
for £1 of earnings. Investors may pay a higher PE
if they think the company is growing or is going to
do better than in the past.
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‘Market Capitalization’, Investopedia http://www.investopedia.com/terms/m/marketcapitalization.asp
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Finding a Company’s PE
Market Share Value
Earnings per Share
If company XYZ cost £20 per share and company
earnings were £1 per share, your equation would
be:
£20 (share cost) = a PE of 20
£1 (earnings/share
Traders may also use the PE ratio to determine if
a stock is more or less valuable than in the past. A
speculative company’s PE ratios may range from
50 to 300. A conservative utility stock may stay
between 8 and 16. If you know your stock typically
has a PE ratio between 20 and 30 and it’s now
trading with a PE ratio of 18, it may be undervalued
and a good buy.
Typically the PE Ratio is based on TTM, the trailing
twelve months of earnings. Sometimes the PE will
be based on the trailing two quarters and the future
two quarters. Or it may be forward looking PE,
anticipating the earnings for the next 12 months.
While the average PE Ratio across all assets is 20
to 25, different sectors have different valuations.
So it’s most useful in comparing companies within
a sector.
Volume tells you how many shares have traded
hands and how actively the stock is trading. A
higher volume means it’s easier to buy and sell as
there’s a lot of interest in trading. A spike in volume
may also indicate a more rapid change in price.
When you compare current volume to average
volume you see if the stock is active or quiet.
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Company valuation lets you determine if you are
paying a high or low price per share relative to the
value of the company.
The PE ratio is a quick valuation. However
companies can use debt to buy back shares. This
makes the PE look better because there are fewer
shares, but it overlooks the debt. It can also allow
for accounting manipulation. Companies can
choose to sell an asset, and add in the profits for
a one-time good report. Or they can sell a spin-
off that was a losing part of the company, and
eliminate that loss from their report.
Wise investors dig deeper. If a company were to
sell off all their assets, take the cash, and pay all
the debts, what is left? That’s the cash value of
the company. Your EV/EBITDA ratio gives you this
number.
Value investors look for exceptionally cheap
companies that have solid management, a good
product, and good prospects. They want to see a
high EPS and a PE below 15. They check to see if
the product has a ‘moat’ around it. That is, how
protected is it from competition? Companies
protect themselves from competition by brand
name, think Coca Cola or Nike. They may protect
themselves with patents as pharmaceuticals do. Or
they may have such a huge market share or unique
product that makes it nearly impossible or vastly
expensive to duplicate. Microsoft and Google fit
here.
Ways to increase the probability you will make
money with a company include:
Buying stock when the company is selling at a
discount, which means the value of the company
is below that of the stock price
High EPS (earnings per share)
Low Debt Ratio
Low EBITDA
4.2 Company Valuation
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Hedge fund buying
Pays consistent and increasing dividends
You can find this information on some trading
platforms, in the annual reports of a company, or
on websites like Yahoo Finance.
Six Ways to Reduce Risk
1. Invest in assets that are not correlated to
each other. Check historic charts to make
sure they don’t fall or rise in tandem. Consider
commodities such as oil, corn, or metals.
2. Trade CFDs, inverse funds, and assets that can
hedge against a downturn.
3. Diversify to CFDs and managed futures that let
you use derivatives to invest in the rise or fall
of a broad range of instruments: Currencies,
commodities, stocks, ETFs, indexes, etc.
4. Diversify into a range of global equities that may
have different cycles and correlations to the UK
or your country’s exchanges.
5. Research and know the strengths and
weaknesses of the equities you choose. Invest
in value.
6. Keep track of your investments. Check for
change in strength, change in trends, upcoming
news events, etc., and adjust your portfolio as
needed.
4.3 Technical Analysis - Making
Sense of Charts and Tools
Charts are valuable tools to help you choose
investments. Choose a chart that matches your
timeline to see the trends that apply to you. Do you
want to hold your securities for a long time? Choose
a daily or weekly chart. Want to hold for a few days
or weeks? Select a one- or four-hour chart. If you
are day trading, you’ll want a one minute chart.
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Charts can be shown as a line, a mountain, a set of
bars, or as candlesticks. Mountains and lines are
good at showing the movement of the security.
Candlesticks give you more precision.
Each candlestick represents the timeframe of
the chart. So if you are looking at a 15 minute
chart, each candlestick shows the maximum and
minimum prices reached during the 15 minute
interval. The solid bottom and top of the candlestick
show the prices at the beginning and end of the 15
minute period. The tails - top and bottom - show
the highest and lowest prices in that timeframe.
Experts use candlesticks to help them predict
changes in direction. A long tail can show resistance
to the price going in the direction of the tail. A
candlestick with a very short middle and long
ends is called a doji and can indicate a change in
direction. When the price begins at the top of the
candle and ends at the bottom, the candle is red.
If the price starts at a lower level and rises in the
candle time period, it is green.
Tools help you make sense of the chart.
Channel: Stocks trend up, down, or sideways.
Within that trend, they tend to stay in a range. The
range can be broad or narrow. Drawing a channel
helps you see that range. To draw a channel,
connect the peaks on the top with a line. Do the
same with the points on the bottom. Connecting
three or more points makes a stronger trend line.
When the security moves above or below the
channel line, it’s called a breakout and may signal
a change in the trend.
The bottom line of the channel is called resistance.
When trading gets to that line, it is more likely
to stop and bounce back. The top line is called
support as trading often reverses when it hits
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that line. When a line is breached, that line may
change from resistance to support, or support to
resistance.
Lines: Sometimes a trend is not formed with
equidistant lines. Use the trend line to draw lines
connecting as many peaks or valleys as you can. If
the trend lines come closer together, a breakout is
inevitable. But which way? If this ‘ag’ comes after
a down turn, it can be referred to as a bear ag,
indicating the likelihood of a continuing downward
trend. If it comes after an up-trend, it can be called
a bull ag with the idea that the asset will go up.
These are simply probabilities. You can look for
high probability trades, but there are no certainties
or guarantees. The market has a mind of its own.
Fibonacci Lines: This is another way of finding
resistance and support lines based on prior moves.
A line is drawn between a peak and a valley. Then
the mathematical formula comes into play. Your
Fibonacci tool draws lines at 23.6%, 38.2%, 50%
and 61.8% of the movement in both up and down
directions. 61.8% is considered the most powerful
line and called the golden retracement. People
don’t know why this ancient formula works; just
that it seems to be an effective predictive tool.
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Investors look at these lines as a place to take their
trade off the table if it bounces there. Or they may
have confidence to let the trade run if it breaches
the line and keeps going. Fibonacci experts often
draw several Fibonacci lines between different
peaks and valleys. As these lines overlap, they
create a stronger sense that support may be found
in that place.
ADX (Average Directional Index): ADX was
developed for the currency and commodity
markets.
The ADX tells you the strength of the current trend
but not the direction.
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A reading below 20 means choppy trading with
no clear trend. A reading above 30 shows strong
trend movement. Traders use this as one of several
indicators that may recommend getting into or
out of a trade. When the ADX is high, you have
an increased probability that the security will be
coming to the end of the trend.
The +DI (plus directional indicator) and –DI (minus
directional indicator) help to define trend direction.
If the ADX is above 20 and the +DI crosses over
the –DI it is considered a buy signal for an upward
trend. When the –DI crosses over the +DI (with
the ADX above 20), that is a sell signal. With this
system, there can be many false stops and starts,
so use other trend direction tools to assist your
decision.
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Alligator: Currency traders use trend lines with
an alligator metaphor on this chart pattern. Lines
together mean the alligator is sleeping, with its
mouth shut, so don’t trade. Open lines show an
open mouth that’s good for trading. In reality, the
lines show trends up, down, or sideways.
All rising lines are bullish. All descending are
negative. When the lines cross over each other, it
indicates a change in direction. When the lines are
close together, it means there is no tradable trend.
The lines are smoothed. moving averages of
different lengths. Periods of 13, 8, and 5 are based
on the time period of the chart. The Alligator tool
will let you set time lengths that suit your trading.
Bollinger Bands®: Bollinger Bands are dynamic
indicators that quickly adjust to market conditions.
This essential indicator shows recent price changes
and measures momentum and volatility. Traders
use Bollinger Bands to see the strength and trend
of a security and to see when to enter and exit a
trade.
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‘Average Directional Index (ADX)’ Stock Charts School
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trade.
Bands expand when the stock is volatile with price
uctuations or strong trends. Bands contract when
the stock is consolidating or moving sideways.
Bollinger Bands usually are set at 2.0 standard
deviations above and below the price. 99% of
all price action falls between 2.5 deviations. So
a breakout of the band is a clear trend signal.
The center line represents the 20-period moving
average. Strong trends have the price closer to the
outer edge of the band.
When the price moves away from the outside band
and closer to the center, the momentum is fading
and the trend may be turning. Candlesticks above
the center line show a bullish trend. When the
stock price falls below the centerline it is indicating
a bearish trend.
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MACD (Moving Average/Convergence/
Divergence): This indicator notes the difference
between a short period exponential moving
average (EMA) with a longer period EMA, usually
12 and 26 days. These lines are shown below the
chart. When the short EMA moves over the longer
EMA it signals the price is rising higher than it has
in the past. This is a bullish sign. Traders may not
want to take short positions here.
When the short EMA drops below the longer EMA,
it shows prices are dropping faster than in the past,
a bearish sign. This may not be the best time to
buy. It’s easier to see the trend against a baseline
since the MACD is below the price chart.
Traders look for the lines to cross over each other
to signal when to enter or exit a trade. They may
also look for divergence. When the MACD is moving
one direction and the price of the commodity is still
moving another, it anticipates a change in trend.
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Rolf, ‘Bollinger Bands Explained– The Best Trading Indicator For Different Purposes’,Tradeciety
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Moving Average (MA): A moving average levels
out random price uctuations on a chart. It is called
a lagging indicator because it uses past data. You
can choose how long of a period of past prices
go into the MA. The longer the period, the longer
the lag time. A shorter MA is more responsive and
better for short-term traders.
Use moving averages to identify trends, support,
and resistance for your trades. When a security
is dropping, it could find resistance based on the
moving averages. If it drops through the 20 day
moving average, the next support might be the 50
day moving average.
As in the MACD, when one MA crosses over
another, it signals an up or down trend. You can
choose a variety of moving averages. Weighted or
exponential moving averages are weighted toward
the most recent data. Triangular MA has the extra
weight in the middle. [Caption: Moving averages
show trends, support and resistance.]
Relative Strength Index (RSI): This index is a
momentum indicator. RSI is said to be in ‘oversold
conditions’ when the index falls below 30. It shows
overbought conditions when the index rises above
70. Traders believe the market is unlikely to sustain
itself for long in either an overbought or oversold
condition. Like a stretched rubber band, it is likely
to snap back to its normal level.
The standard look-back period for RSI is 14. A
lower number increases sensitivity to change.
Just because the indicator says a security is
overbought does not mean it will correct or correct
immediately. Securities can continue their current
trend while the RSI says it’s overbought or oversold.
Sometimes the equity will consolidate and work
off the overbought condition before continuing
higher. It is just one tool that recommends caution
when certain levels are reached.
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A divergence between the RSI and the security
price may indicate a coming trend change. If the
security is making higher highs, while the RSI is
making lower highs, that is a bearish sign. If the
security is making lower lows and the RSI is making
higher lows, it indicates a possible breakout to
the upside. Divergences are less trustworthy in a
strong trend and a better indicator when they form
after overbought or oversold readings.
Use Multiple Charts: At times it’s useful for
traders to have several charts on their screen at
one time. They may want to see how an asset is
trending on a short term chart like a one-minute
or five-minute chart as well as on a daily chart. Or
they may want to have some leading indicators on
the screen. Transports or futures may indicate a
market trend for a specific stock. Or index charts
may help traders decide when to enter or exit a
trade. Finally, some traders prefer to have Bollinger
Bands, Fibonacci lines, or other indicators on
separate charts so the charts are not too cluttered.
eToro helps new and skilled traders see a variety
of charts in real time with their new feature called
ProCharts.
ProCharts give traders the opportunity to show
multiple charts on their screen. It is exceptionally
customizable. Traders can choose the:
Number of charts on the screen
Chart locations on the screen
Assets represented
Time frames represented
Traders can easily move the charts around to
better support their unique trading analysis. Once
the charts are set up, they will appear the same
way each time you access them.
Don’t allow fundamental analysis and chart reading
to seem daunting. There are so many tools to help
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you, it might feel like a lot to take in at first, but
take it one step at a time. You will learn to use
these tools and they will make you a much better
trader. The difference between successful and
unsuccessful traders is the skill to know when to
enter and exit a trade. These tools help you see
the trends and the changes in direction. They are
designed to let you know when the security may
stop going up or down. Then you may choose to
buy and sell at these points, you have a distinct
advantage. You are not trading blindly.
None of these indicators are guarantees. They don’t
predict the future, they only indicate a probability
of a direction. To gain experience, practice on a
virtual account. Get a feel for how these tools work
and how they apply to the securities you want to
trade. Then you can trade with more confidence.
Your capital is at risk. Past performance does not guarantee future results. This information is for educational purposes and not investment advice.
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