Basic analysis gives you a quick overview of a company without indepth examination of its balance sheet or mathematical analysis.
It helps you build basic knowledge of a number of companies. This means that when important announcements are made you can capitalise on any potential movement in their share price.
Step 1: read the news
Start by picking a handful of companies that you wish to analyse (read the previous lesson for an overview of how to shorten your list down to this level). Then start looking through the financial press for an overview of what's happening with those companies right now.
Look for the following:
- General performance of the companies' share price over the last three to six months
- New innovative products or projects that they are working on
- Any possibilities that one company is a target for a merger or acquisition (M&A)
- Analyst buy/sell recommendations and commentary on any of the companies
- Important expectations or upcoming announcements
Now, start recording this information on each company. Although you will be performing only basic analysis, it is important to note down any of the above that you find evidence of.
Step 2: consider different scenarios
From the information you have collected above, you can now start creating imaginary scenarios that you would be able to use as trading opportunities.
Start by working through the list of recent and likely events you have compiled for each company and try and work out what might happen to its share price under a range of different outcomes.
Any outcome that supports what you already know is likely to be priced into the company share price already.
However, if something changes – a plan goes wrong, an M&A deal collapses – this will not be priced in (at least fully) and you will be able to trade on the back of that.
Example
Consider Company A, a technology firm:
- It has a new product in development that is being touted as revolutionary.
- The product is scheduled to be unveiled at an upcoming company event in two weeks' time.
- Market hype surrounding this product has led to a 25% increase in the company's share price over the past month.
- The information is widely available online, in business magazines and numerous other resources.
The above information means that the market has already priced in the expectation of this new product release. Start imagining what could happen to Company A's share price if, for example, it announces a delay, cancels the project, faces additional costs, brings release of the product forward or simply comes out with a less impressive product than expected.
If this actually happens, then you know that you can look for short-selling opportunities.
Step 3: weigh up the odds
Once you have made a list of these potential scenarios, categorise them by likelihood:
- Highly likely – the market has priced in the product being as impressive as markets already expect. This is already priced into the share with the 25% recent increase.
- Possible – the product's launch could be brought forward. This outcome has not been fully priced in.
- Unlikely – the product is not as revolutionary as thought. Although this outcome is not priced in, some traders may be holding positions in expectation of this.
- Very unlikely – the product is cancelled. The market is not expecting this at all so it has not been priced into the share at all.
Now go through the list above and decide whether and how much the company's share price might go up or down if any of these outcomes materialised.
This will help you decide whether to go long or short of the shares if news that you have mentally prepared for does suddenly break.
Step 4: technical analysis
In this event that any of the above scenarios do materialise, go straight to your price charts and use technical analysis to find entry and exit points for the long or short trade you have chosen.
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