Lesson 5: Using fundamental and technical analysis to pick stocks

When you begin to research stocks and make selections for your portfolio, you might run into a number of common challenges. Many investors face similar hurdles and here are some of the reasons why:

• Information overload: There are many stocks to choose from — Canadian, U.S. and international — and it can be overwhelming to gather and analyze the information you need to make an informed decision. In addition to company-specific data, you’ll want some understanding of how the economy works and where we are in the current economic cycle.
• Identifying a reasonable price: Even after you’ve analyzed and chosen a few suitable stocks, you’ll want to develop an idea of a reasonable price level to buy and sell.
• Emotional bias: While it's natural to be drawn to companies that you're familiar with or that have a personal connection to you, this emotional bias can sometimes cloud your judgement and may lead to poor investment decisions. On the other hand, familiarity with a company or industry can mean you have certain genuine insights, insights that other investors may be missing.

Let’s explore fundamental and technical research to understand how these tools can simplify investment choices.

Some investors start with fundamental research, a tool to better understand a company and the industry it operates in.

Here are some things to consider when you begin your company research:

1. Start with the fundamentals. Look at the company's financial statements, including its income statement, balance sheet and cash flow statement, to understand its financial health and stability. Some key data to consider includes revenue growth, earnings per share, profit margins and return on equity.
2. Study the industry. Look at the company's place in its industry, including its market share, competition and industry trends.
3. Consider the management team. Evaluate the company's leadership and management team, including their track record and experience.
4. Explore future growth potential. Consider the company's growth prospects, including its plans for expanding its business, entering new markets or launching new products.
5. Pay attention to current events. Understand how current events could impact the company's future. These could include changes in the economy, regulation or competition.

The goal of your research is to understand the company's strengths and weaknesses, and how it’s positioned for future success. Some market professionals recommend that you look for companies with a strong financial track record, solid management and a competitive advantage in their industry. Another approach is to consider investing in companies that have overcome adversity and experienced a decline in stock price, but are now showing signs of growth and the potential for future gains.

Investing in individual stocks is often a long-term commitment, and it's important to have patience and a well-thought-out strategy. With the right approach and the right resources, you can increase your chances of picking a great stock that appreciates over time. Don’t forget that a company’s situation can change and it’s smart to keep up with developments once you’ve included a stock in your portfolio.

You can use technical analysis as another tool to help make informed investment decisions. Keep in mind, however, that technical analysis is just one aspect of stock picking.

Here are some of the things you should know about technical analysis:

1. Technical analysis involves looking at past market data, such as price and volume trends, to make predictions about a stock's future performance.
2. Common technical analysis techniques include chart pattern recognition, trend analysis and moving averages.
3. Technical analysis is best used in conjunction with fundamental analysis, where you develop an understanding of a company's financial health and future growth prospects.

One common way technical analysis is used is to narrow down the number of stocks under consideration for a portfolio. Here are just two examples of how traders use technical analysis.

Use volume data. There are a number of ways to use a stock’s volume information. You might decide to trade stocks that have a certain minimum amount of daily volume, as a way to ensure that the stock is reasonably liquid and can be bought or sold with relative ease. For example, you perform an analysis that ranks all financial stocks by daily trading volume and consider investing in those with daily volume in the top 100. You could also scan for unusual changes in daily volume, as that might point to increased investor interest in a stock, positive or negative. This can be the result of many things. Perhaps a news story breaks that’s relevant to that stock or the stock reaches a price that attracts traders’ interest.

Look for momentum. Some technical traders look for strong, up-trending stocks for potential buying opportunities. One way to identify this is to use moving averages, which are trend-following indicators that smooth out day-to-day price movements to show a stock's general direction over time. Moving averages can also help to identify support and resistance levels. Support is where downward trends tend to wane as buying pressure overcomes selling pressure. In contrast, resistance often occurs at a price level where selling pressure overcomes buying pressure and the stock may, at least temporarily, encounter difficulty moving higher.

Are you wondering what kind of technical analysis has the best track record for picking winning stocks?

The truth is the effectiveness of technical analysis varies — there’s no single technique that has the best track record for picking winning stocks. Think of technical analysis like another tool in your toolkit that can help you understand price action. Put simply, a stock’s price reflects how investors perceive and value it. This is true for both historical data and stock behaviour in the current market environment.

While technical analysis incorporates an analysis of a stock’s past price performance, it’s not a guarantee of future performance. When used together with fundamental analysis, however, technical analysis can improve your understanding and let you make better informed investment decisions.

Once you’re ready to start, log onto your Investor’s Edge account and go to Quotes and Research, where you’ll find a number of tools to conduct fundamental and technical analysis.