Investing and trading have been around in various forms since money was invented, but for the purposes of this paper, I would like to look at narrower, goal specific definitions for these terms. Investing is commonly understood in the financial industry as, long term, 1 – 10 years. But trading is could constitute anything from milliseconds upwards. The goal of investing and trading is the same, to make money or to hedge risk. The question this paper would like to investigate are the merits for technical versus fundamental approaches.
Fundamental investing (FA)
Investopedia defines Fundamental investing as:
“A method of evaluating a security that entails attempting to measure its intrinsic value by examining related economic, financial and other qualitative and quantitative factors. Fundamental analysts attempt to study everything that can affect the security's value, including macroeconomic factors (like the overall economy and industry conditions) and company-specific factors (like financial condition and management).
The end goal of performing fundamental analysis is to produce a value that an investor can compare with the security's current price, with the aim of figuring out what sort of position to take with that security (under-priced = buy, overpriced = sell or short).
This method of security analysis is considered to be the opposite of technical analysis.”
(http://www.investopedia.com/terms/f/fundamentalanalysis.asp)
Technical Analysis (TA)
Investopedia defines Technical Analysis as:
“A method of evaluating securities by analysing statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use cha...
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... dice are thrown or the wheel is spun. But over a large number of bets, the gains and losses average out to a result that can be predicted, even though the result of any particular bet cannot be predicted (Fig. 3 . 8 ).
The casino operators make sure the odds average out in their favour. That is why casino operators are so rich. The only chance you have of winning against them is to stake all your money on a few rolls of the dice or spins of the wheel.
It is the same with the universe. When the universe is big, as it is today, there are a very large number of rolls of the dice, and the results average out to something one can predict. That is why classical laws work for large systems. But when the universe is very small, as it was near in time to the big bang, there are only a small number of rolls of the dice, and the uncertainty principle is very important.”
Analysing the ratio of one with the other in the industry provides for better understanding about the performance of the company in market. An investor has to make a comparative analysis before making any investment decision.
The Dow Theory suggests that all information (of the past, present or future) is factored into the prices of stocks and indexes. It includes all micro and macro economic factors ranging from inflation to earnings.
In essence, it is a bet that only costs you a small amount, but that offers you a very large return. The only downside is that the odds of you winning are tiny (like a lottery), except the unlike the lottery you are thousands of times more likely to win.
The goal is to teach you to wear the glasses of a professional trader who sees the difference between low and high-probability trades. With these new glasses, your trading account gradually reflects the consequences of making high-probability trades. With more money in your trading account, you can buy more contracts. You experience the law of compounding, and your account grows exponentially.
Bloomfield stresses the use of statistics extracted from data rather than the use of data itself. Few investors’ trade based on costly statistics, which means markets do not reflect these costly statistics completely. These statistics are also data which many t...
Mutual-fund managers generally rely on some variation of the two classic schools of stock analysis: fundamental and technical. Fundamental analysis relies on information such as economic supply and demand, and the company's financial health. These investors use information such as annual growth rate, earnings records, and key ratios to make decisions and focus on consistent, steady growth. Alternatively, technical analysis focuses more on the study of timing, price fluxuation, and investor sentiment. A common method of technical analysis is the usage of a chart of the stock’s price history to predict market sentiment and stock price trends.
You play a game of chance when you walk into a casino because the odds are usually against you. Chance is defined as the probability that a particular outcome will occur. For example, on a spinning roulette wheel, how likely it is that a ball lands in a black compartment marked “twenty-two.” Our knowledge about the gamble, about the odds of winning, is irrelevant to the outcome of the gamble. If someone walks into a casino and is asked “guess a number between one and ten”, our knowledge of the odds of guessing the correct number has no impact on whether you guess the correct one. Everything a casino has to offer is based on probabilities. When you walk away from a slot machine or a poker table, your pockets either contain more or less money than what you started with. In order for casino gambling to work, the house (the organization of a gambling game) must win majority of the time. Another way of saying that is the total amount of winnings must be lower than the amount paid to gamble. This is the main reason people do not go into the casino with a plan to win money. When considering to gamble, the average gambler will lose money rather than win. With that being said, the gambler must believe a lie which is why many casinos consider themselves as a type of entertainment. This is the reason that the Harrah’s, Caesars, and the Bellagio are advertised in movies, theme parks, and also baseball
Casinos have developed formulas to calculate the “predicted lifetime value” of any individual gambler. Gamblers are assigned value rankings based on this amount; the biggest losers are referred to as “whales.” These gamblers become the casinos’ most sought-after repeat customers, the ones to whom they market most aggressively with customized perks and VIP treatment. (Rosengren,
The efficient market hypothesis has been one of the main topics of academic finance research. The efficient market hypotheses also know as the joint hypothesis problem, asserts that financial markets lack solid hard information in making decisions. Efficient market hypothesis claims it is impossible to beat the market because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information . According to efficient market hypothesis stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments . In reality once cannot always achieve returns in excess of average market return on a risk-adjusted basis. They have been numerous arguments against the efficient market hypothesis. Some researches point out the fact financial theories are subjective, in other words they are ideas that try to explain how markets work and behave.
The efficient market, as one of the pillars of neoclassical finance, asserts that financial markets are efficient on information. The efficient market hypothesis suggests that there is no trading system based on currently available information that could be expected to generate excess risk-adjusted returns consistently as this information is already reflected in current prices. However, EMH has been the most controversial subject of research in the fields of financial economics during the last 40 years. “Behavioural finance, however, is now seriously challenging this premise by arguing that people are clearly not rational” (Ross, (2002)). Behavioral finance uses facts from psychology and other human sciences in order to explain human investors’ behaviors.
The standard investment advice to all investors was to identify securities that offered best return with lowest risks and then make a portfoli...
There is a sense of complexity today that has led many to believe the individual investor has little chance of competing with professional brokers and investment firms. However, Malkiel states this is a major misconception as he explains in his book “A Random Walk Down Wall Street”. What does a random walk mean? The random walk means in terms of the stock market that, “short term changes in stock prices cannot be predicted”. So how does a rational investor determine which stocks to purchase to maximize returns? Chapter 1 begins by defining and determining the difference in investing and speculating. Investing defined by Malkiel is the method of “purchasing assets to gain profit in the form of reasonably predictable income or appreciation over the long term”. Speculating in a sense is predicting, but without sufficient data to support any kind of conclusion. What is investing? Investing in its simplest form is the expectation to receive greater value in the future than you have today by saving income rather than spending. For example a savings account will earn a particular interest rate as will a corporate bond. Investment returns therefore depend on the allocation of funds and future events. Traditionally there have been two approaches used by the investment community to determine asset valuation: “the firm-foundation theory” and the “castle in the air theory”. The firm foundation theory argues that each investment instrument has something called intrinsic value, which can be determined analyzing securities present conditions and future growth. The basis of this theory is to buy securities when they are temporarily undervalued and sell them when they are temporarily overvalued in comparison to there intrinsic value One of the main variables used in this theory is dividend income. A stocks intrinsic value is said to be “equal to the present value of all its future dividends”. This is done using a method called discounting. Another variable to consider is the growth rate of the dividends. The greater the growth rate the more valuable the stock. However it is difficult to determine how long growth rates will last. Other factors are risk and interest rates, which will be discussed later. Warren Buffet, the great investor of our time, used this technique in making his fortune.
It is regarded as one of the best ways to evaluate the value of stocks. The objective is to discover their true value by examining many factors including debt load, profit margins, cash flow and P/E ratio and etc. For example, if a trader was to analyze Samsung Electronics, he/she will look at every single factor that can affect the stock’s value, such as the smartphone market and their management. And in the end, if the company is over-valued, the stock will be sold and if it is under-valued, it will be bought.
This paper will define and discuss five financial theories and how they impact business decisions made by financial managers. The theories will be the Modern Portfolio Theory, Tobin Separation Theorem, Equilibrium Theory, Arbitrage Pricing Theory (APT), and the Efficient Markets Hypothesis.
Prospective investors make use of financial statements to assess the viability of investing in a business. Financial analyses are often used by investors and is prepared by professionals (financial analysts), thus providing them with the basis in making investment decisions.