What Is Stock Market Analysis?
Stock market analysis is the analysis of the general stock market, a specific sector or an individual stock. Its purpose is to uncover price discrepancies that exist in the current market. There are two major approaches to analysis. One involves fundamental analysis to uncover stocks whose current price differs from its potential value. The second uses technical analysis to forecast a stock's change in price, based primarily on its price history.
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Function
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The function of analysis is to break down complicated subject matter into smaller parts to gain deeper understanding. Implicit in stock market analysis is the belief that prices do not move randomly. If true, then there must be some logical order behind their movements. Investors seek to discover this order through analysis, in an attempt to profit consistently.
Benefits
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The major benefit in using analysis is the reduced reliance on probability. Luck is a poor way to become financially successful. In theory, with rigorous analysis, one should be able to determine what makes it successful. A continued review of prior stock analysis can lead to further refinements, improving the chance of future returns.
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Types
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Stock market analysis falls into one of two categories: fundamental or technical. Fundamental analysis is an involved process that does not lend itself well to automation. It requires a knowledge of accounting, finance, the company, its products and the industry's prospects. This kind of analysis requires human judgment. Technical analysis places greater emphasis on computers for data analysis. The rise in popularity of technical analysis appears to coincide with the rise of computers and the Internet.
Considerations
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The financial world is extremely competitive, with many experts touting their success. However, given the number of people investing in financial markets, you will have a normal distribution of results. Some people will be outstanding, some will do better and most will end up in the middle.
Stock market analysis is neither rigorous enough nor is the population sample (trades won and lost) large enough to draw a definitive conclusion. It is possible that an investor's success, despite her apparent skill, is the result of chance. In addition, it can be difficult, if not impossible, to determine whether the results occurred as a result of too much risk or leverage.
Misconceptions
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A common misconception is that successful investors can predict the future. A second misconception is that their analytical abilities are the key to investment success. Financial history is ripe with spectacular failures. Barings Bank (1995), Long Term Capital Management (2000) and Lehman Brothers (2008) are examples of companies that failed due to poor risk management. Investors are paid to take risk, but no one has unlimited capital. Excessive risk can result in spectacular returns but can also cause bankruptcy if the risk is managed improperly.
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References
- "Stanford Encyclopedia of Philosophy": Analysis
- "The Wall Street Journal: Are Markets Efficient?"
- FooledByRandomness: Technical Papers Associated with The Black Swan. The Impact of the Highly Improbable (2007-2010)
- EpicSystems Debtor Matrix: Lehman Brothers
- NumaWeb: The Bank of England Report Into the Collapse of Barings Bank
- Ambit ERisk: Case Study LTCM: Long Term Capitol Management
Resources
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