Can We Please Get This One Basic Thing Right? (Part III)

Yeah, we’re digging deeper.

How does an investor arrive at an investment decision?

It’s pretty obvious to us by now that traders and investors have their own rationales for entry and exit, and that these rationales are pretty much diametrically opposite to each other.

So, what’s the exact story here?

The seasoned investor will look at FUNDAMENTALS, and will exhibit PATIENCE before entering into an investment.

The versatile trader will look at TECHNICALS, and will NOT BE AFRAID of entry or exit, any time, any place. He or she will be in a hurry to cut a loss, and will allow a profit to blossom with patience.

What are fundamentals?

Well, fundamentals are vital pieces of information about a company. When one checks them out, one gets a fair idea about the valuation and the functioning of the company, and whether it would be a good idea to be part of the story or not.

A good portion of a company’s fundamental information is propagated in terms of key ratios, like the Price to Earnings Ratio, or the Debt to Equity Ratio, the Price to Book Value ratio, the Enterprise Value to EBITDA Ratio, the Price to Cash-flow Ratio, the Price to Sales ratio, etc. etc. etc.

What a ratio does for you is that in one shot, it delivers vital info to you about the company’s performance over the past one year. If it’s not a trailing ratio, but a projected one, then the info being given to you is a projection into the future.

What kind of a promotership / management does a company have? Are these people share-holder friendly, or are they crooks? Do they create value for their investors? Do they give decent dividend payouts? Do they like to borrow big, and not pay back on time? Do they juggle their finances, and tweak them around, to make them look good? Do they use company funds for their personal purposes? Researching the management is a paramount fundamental exercise.

Then, the company’s product profile needs to be looked into. The multibagger-seeking investor looks to avoid a cyclical product, like steel, or automobiles. For a long-term investment to pan out into a multibagger, the product of a company needs to have non-cyclical scalability.

After that, one needs to see if one is able to pick up stock of the particular company at a decent discount to its actual value. If not, then the investor earmarks the company as a prospective investment candidate, and waits for circumstances to allow him or her to pick up the stock at a discount.

There are number-crunching investors too, who use cash-flow, cash allocation and other balance-sheet details to gauge whether a coveted company with an expensive earnings multiple can still be picked up. For example, such growth-based investors would not have problems picking up a company like Tata Global Beverages at an earnings multiple of 28, because for them, Tata Global’s balance-sheet projects future earnings that will soon lessen the current multiple to below sector average, for example.

Value-based investors like to buy really cheap. Growth-based investors don’t mind spending an extra buck where they see growth. Value-based investors buy upon the prospect of growth. Growth-based investors buy upon actual growth.

The trader doesn’t bother with fundamentals. He or she wants a management to be flashy, with lots of media hype. That’s how the trader will get volatility. The scrips that the trader tracks will rise and fall big, and that’s sugar and honey for the trader, because he or she will trade them both ways, up and down. Most of the scrips that the trader tracks have lousy fundamentals. They’ve caught the public’s attention, and the masses have sprung upon them, causing them to generate large spikes and crashes. That’s exactly what the trader needs.

So, how does a trader track these scrips? Well, he or she uses charts. Specifically, price versus time charts. The trader doesn’t need to do much here. There’s no manual plotting involved. I mean, this is 2012, almost 2013, and we stand upon the shoulders of giants, if I’m allowed to borrow that quote. Market data is downloaded from the data-provider, via the internet and onto one’s computer, and one’s charting software uses the data to spit out charts. These charts can be modified to the nth degree, and transformed into that particular form which one finds convenient for viewing. Modern charting software is very versatile. What exactly is the trader looking for in these charts?

Technicals – the nitty-gritty that emerges upon close chart scrutiny.

How does price behave with regard to time?

What is the slope of a fall, or the gradient of a rise? What’s the momentum like?

What patterns are emerging?

How many people are latching on? What’s the volume like?

There are hundreds of chart-studies that can be performed on a chart. Some are named after their creators, like Bollinger bands. Others have a mathematical name, like stochastics. Names get sophisticated too, like Williams %R, Parabolic SAR and Andrew’s Pitchfork. There’s no end to chart  studies. One can look for and at Elliott Waves. Or, one can gauge a fall, using Fibonacci Retracement. One can use momentum to set targets. One can see where the public supports a stock, or where it supplies the stock, causing resistance. One can join points on a chart to form a trendline. The chart’s bars / candle-sticks will give an idea about existing volatility. Trading strategy can be formulated after studying these and many more factors.

Where do stops need to be set? Where does one enter? Exit? All these questions and more are answered after going through the technicals that a chart is exhibiting.

One needs to adhere to a couple of logical studies, and then move on. One shouldn’t get too caught up in the world of studies, since the scrip will still manage to behave in a peculiar fashion, despite all the studies in the world. If the markets were predictable, we’d all be millionaires.

How does the trader decide upon which scrips to trade? I mean, today’s exchanges have five to ten thousand scrips that quote.

Simple. Scans.

The trader has a set of scan criteria. He or she feeds these into the charting software, and starts the scan. Within five minutes, the software spits out fifty odd tradable scrips as per the scan criteria. The trader quickly goes through all fifty charts, and selects five to six scrips that he or she finds best to trade on a particular day. Within all of fifteen minutes, the trader has singled out his or her trading scrips.

Do you now see how different both games are?

I’m glad you do!

🙂

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