There is nothing more dangerous than putting a large chunk of money you need into something you do not understand. A perfect, more recent example of this is the GameStop frenzy where many people bought into it at peak reddit mania when it was above $400, since then it has not really come anywhere near that again and lots of regular people were left holding the bag.
If you looked at just reddit you would see that this was a once in a lifetime opportunity to get rich quick and squeeze the suits out of their money. However, if you were to actually analyze the stock itself it would have been clear that it was not a good idea to buy at that peak. So lets talk about the 2 most common ways investors analyze stocks to make more educated decisions.
- Fundamental analysis
Fundamental analysis involves taking a 10,000 foot view of a company to try and gauge what it’s intrinsic value actually is, and if it is worth what it is being currently sold at. Some common things that investors look at when taking this approach include:
- Profit margins
- Growth and size of the company now and over time
- Expenses the company has to cover
- Earnings per share
- Company leadership and their track record
- Value of the sector they operate in (tech, healthcare, energy, gaming etc.)
Fundamental analysis is certainly a useful tool, especially when looking at investing in something over the long run. In the case of GameStop, if you look at their reported company earnings over the past couple years their revenue has gone down by billions of dollars. I would argue this is because they have not been able to keep up with the presence of 100% digital game sales on consoles and PC, and hardware sales in many other places (Microsoft/Sony direct sales, Amazon, other retailers). And while it is true that they recently changed their leadership to include executives with a strong track record in e-commerce, which helped boost the initial mania, to me that still is not enough to establish itself as a power presence in the gaming industry.
On the other hand if you do a fundamental analysis of a company like Amazon, there are certainly much more pros than cons. They have insanely high growth and revenue that spans across multiple branches (e-commerce, AWS, Amazon Fresh, Prime, Kindle, etc.), and over time have managed to create systems to reduce supply chain bottlenecks and improve overall efficiency of the company as a whole. And it does not take an expert to tell you that they are by far the most dominant force in e-commerce worldwide (aside from maybe Alibaba in China and a few other countries).
This type of analysis however, is very susceptible to day-to-day news. For example if a report comes out that a company may be cooking their books, or that their revenue is going to be a big miss for the previous quarter, that makes investors quite nervous so they sell off in anticipation of the price going lower. On that same end, you may one day hear a company’s CEO on the news talking about a big deal about to go through for them that is going to skyrocket revenue. The problem here, is that people lie. They say these things to pump up their company and get people invested in it, because why would you not if it was your company and you had a chance to pump it up on national TV? Not to say that every CEO or executive is lying when they speak, but the reality is you just never know, and you will never know how other investors are interpreting what they say (which is important to remember because not everybody thinks like you do).
2. Technical Analysis
Technical analysis involves using charts to track and assess the price and movement of a stock. There are hundreds of indicators and ways to incorporate this type of analysis, however from my experience the only 2 that are really necessary are price and volume. The technical charts are great in that they represent every single investor and trader in the market. Everyone from the average person spending their stimulus check on GameStop, to the large corporate whales with billion dollar budgets that regularly spend tens or hundreds of millions of dollars on a single trade are represented in the charts. So in this sense, you can get a feel for how other investors are acting on a certain stock and you can correlate that with human emotion to ride momentum plays.
The beauty of technical analysis is that it is 100% subjective in what the market is doing. There is no input from executives, no biased reporting, and no reason to believe it will go one way or the other. It just does what it does, and technical analysis helps give you indicators on what it is going to do and potentially when so you can take advantage of opportunities it presents you with.
For example if you are looking at a chart, and you see that a large volume of traders start buying a stock then that means a lot of people believe it is valuable and will continue going up in price. This increased buying leads to an increase in price, and there would be no way to know that all of these people are buying a stock and driving price up without looking at a chart.
If you are new to stock analysis then it is normal to not really understand what is going on and why. However, the most important thing you can do is to start educating yourself on what is happening, and not be ignorant in thinking you know something that you really do not. It does not mean devoting your life to being a trader, or having to understand every little nuance of the market, but if you can conceptually have an idea of what is going on you are much more likely to make some money in the short and long term. I will have more stories breaking down the different types of analysis in the future, hopefully some of them will help you to grow and develop as an investor and make some money. Until then, google is your best friend, there are many resources out there to make you wiser with your money so you can make better decisions.
And always remember, your #1 job as an investor is money management and not losing money.