Stock Fundamental Analysis - A Key Component for Success

When it comes to investing in the stock market, one measurement stands out above the rest; how much did the investor earn at the bottom line. Traders use many tools to help determine their stock trading plan, but the best tool for assisting an investor is basic stock fundamental analysis. Stock fundamental analysis is the process of examining businesses at the most essential levels. This method of review evaluates key risk reward ratios of a business to attempt to determine the stability and financial health of a company and to determine the value of its stock. 

Many investors use stock fundamental analysis alone for their determination of future stock purchases. While stock fundamental analysis is a powerful practice, it should be an important part of an investor’s overall stock trading plan. This plan should include stop loss strategies, as well as a stock trading system such as Japanese Candlesticks. Such a trading system, coupled with basic fundamental analysis can provide the trader with a valuable insight into the murky waters of the stock market.

Basic fundamental analysis helps an investor to know how much money a company earns. This is the ultimate measurement of its success, both currently and in the future. Earnings can be difficult to calculate, but that is to be expected when dealing with the stock market. When a company is growing and profitable, its stock generally increases; earnings create higher stock prices and in some cases, regular dividends and successful trading. Lower stock value can have the opposite effect, making the market bearish on the stock. By evaluating a stock with stock fundamental analysis, it is possible to look for basic candlestick chart formations and determine the direction of a stock. When the direction is known, an investor can implement stock market strategies which reflect either a bullish or bearish approach.

In addition to understanding a company’s earnings, there are a number of ratios involved in basic fundamental analysis that help the investors to evaluate the worth of a company’s stock. These ratios focus on earnings, growth and value in the market. Evaluating these dynamics together can provide unique reflections on the value of the company. When a company can be identified by basic fundamental analysis, its stock can be tracked using candlestick chart analysis. With this information, an investor can move confidently to make a trade. 

Stock fundamental analysis is a key component in any trading plan. Investors can find patterns and trends in the stock price history and use this information to help make decisions about a company’s value and the value of its stock. Incorporating a stock trading system such as Japanese Candlesticks teams up with stock fundamental analysis to form a powerful team in evaluating stock. 

The bottom line is the ultimate measure of the success of an investor. Using basic fundamental and technical analysis, a stock trading plan and a stock investing system, an investor increases the possibility of moving from the hope of being a good trader to the reality of becoming a highly successful trader.

Risk Reward Ratios

Risk reward ratios are a critical component to successful trading. Trading can quickly become gambling if you continue to press your bets by taking positions with poor risk reward ratios. While identifying good risk reward ratios does not guarantee success, ignoring them usually guarantees failure.

Candlestick traders look for patterns with proven higher probabilities for placing trades. Once the pattern is identified, the next step is determining entry and exit points. For both, profit targets and stop loss targets. These points can be determined based upon moving averages, Bollinger bands, or other technical indicators to evaluate possible support and resistance levels. The onslaught of computerized trading programs provides traders with quick calculations to base one’s risk/reward targets.
Calculating Risk Reward Ratios
let’s assume our computerized scanning program provides us with a dozen high probability patterns from which to choose. Most traders will only be able to add one or two new positions to their portfolio. This is where utilizing risk reward ratios come into play.

The simplest calculation will take into account:

1) Entry Price

2) Profit Target

3) Stop Loss Target 

For example:

Stock XYZ has the Entry Price of Rs20.35 with our Profit Target of Rs21.50 and Stop Loss target of Rs19.85.  Our Risk = the difference between our Entry Price of Rs20.35 and our Stop loss of Rs19.85 or Risk = .50.  Our Reward is the Entry Price of Rs20.35 plus the Profit Target of Rs21.50 or Reward = Rs1.15. We are risking .50 to make Rs1.15. In this example a little better than a 2:1 ratio the rule of thumb for a reasonable risk reward ratio is a minimum of 2:1. It is important to analyze your potential loss in the event your analysis is wrong and the trade does not follow in the expected direction. And no fair setting your targets using fuzzy math the risk reward ratio is meant to provide an unemotional evaluation before risking your hard earned money. Don’t ‘jiggle’ the figures to justify the trade.

Use this approach to narrow down your trades until you find the highest probability patterns with the greatest risk reward ratio. The more systematic you become in evaluating your trades the more likely your portfolio will prosper. Additionally, this approach helps to remove emotional trading which is a continued struggle for many investors.

Where to Begin
Evaluate you’re previously closed positions, using both your winning and loosing trades. Since you should constantly be evaluating your previous trades to evaluate the success of your most important technical analysis tools, you will kill two birds with one stone. Yes, I realize this is a boring exercise but it is essential to your success. The old adage ‘Insanity is doing the same thing over and over again but expecting a different outcome’ was never more true. At least take the time to consider whether you want to add the risk reward ratio to your trading criteria.

There is another other element to consider after the risk reward ratio has been determined. What is the length of time you expect to be in the trade? The shorter the time period the more trades you can place and the more money you can make. A 5:1 ratio is less attractive if your opportunity money will be tied up for too long a period. You must use your capital on the highest probability trades. Using the simple risk reward ratio should produce more profits to your portfolio.

To summarize; you should be willing to risk Rs1 to make Rs2. You should not be willing to risk a Rs1 to make a Rs1. Keep it simple and keep your targets honest, (the data is only as good as the person plugging in the figures).

By doing the risk reward calculations for every potential trade you will have your exit criteria before placing your trade. This keeps you from getting greedy when your profit target has been reached. You can take your profit and re-enter if the new trade meets your criteria. This also helps you from dropping your stop-loss, in the hopes that your trade will soon go your way.

What if I determine one of my open positions has a poor ratio?

Over the years, I have found one of the best ways to evaluate if it is time to take a loss is to look at my existing trade as if I were considering placing it today. If I could not justify taking it at the current price, using the same criteria I use for entering a trade, then it is time to take a loss. If you would not buy it today then more than likely, you already know the answer. Allowing your losses to grow is not a good habit to get into. Hoping and praying are not profitable stock market trading tools. The key is to win more than you lose. Loses are simply the cost of doing business. Every business has an income and expense allowance and candlestick stock trading is no different.

Stop Loss Strategies

Check out our Stop Loss Strategies & Techniques Training Video!

A 'stop loss' is a pre-defined point at which you will get out of a position in a stock based on the idea that it is not moving in the direction that you had anticipated. Every successful and experienced trader utilizing the basics of stock market investing will tell you that establishing and adhering to a reasonable stop loss is extremely important if you are going to make profits in the long run.

There are many reasons why traders will not sell shares when a loss is imminent. This is problematic because there will be many occasions when a trade they enter does not head in the right direction. At times, it is difficult to adhere to the rule of 'cutting your losses' when it obviously the right thing to do. This is often done by traders who feel a strong sense of greed and fear, or an unearned feeling of self-confidence, and may find it difficult to close the trade because, in doing so, it acknowledges the fact that they got the trade wrong in their minds. This may be a bitter pill to swallow so the easier option is to keep the trade open in the hopes that their ego will not be adversely affected. Yet, they will be violating one of the most important trading rules there are. To most traders, the idea of not closing a trade at a loss means that they haven't had a loss despite the fact that they may have a larger loss down the road.

A detailed plan that guides successful traders when to close positions is one of the things that separates them from the majority of the stock market community for them, this is a necessity. It is fair to say that a lot of traders don't have a clue about what conditions would warrant closing a trade. It is also fair to say that the majority of market participants routinely adopt a 'buy and hold' approach.

While a stock market investing strategy will always require decision making, there are no more important decisions you have to make than when to sell shares. This part of trading is often overlooked its importance is frequently underestimated. The act of buying simply puts one in a position where money can be made. It's the act of selling a position that is directly related to whether or not any money is made from the trade.

When it comes to considering your stock market investing strategy for exiting, what is important is not the manner in which you decide to exit, but the fact that you have a plan in place to advise you when to exit. What is also important is that you remain consistent in whatever approach to exiting you adopt.

Selling shares is probably the most complex money management decision you will face but, as a rule, it is the most important. The decision is especially difficult when you are faced with a loss and all you want to do is wait for the shares to return to your buying price. When the shares move away from you, making your loss even greater than you would have ever imagined, it makes the situation even more difficult.

Regrettably for many traders, they cannot bring themselves to set stop losses. If they do, they abandon them when the pressure is turned on. To make money investing in stock, cutting your losses is one of the most important trading rules there is. If you fail to do that, you are most likely going to be worse off for it.