Practical Investing

Investment in equity market is all about stock selection. People spent a lot of time finding the best stock at the best possible price without knowing the fact what makes a certain stock a good investment. Any stock, at given point in time, can be a good or bad investment depending on the market environment. From the hindsight, we can say that the safest stocks one can find at the Karachi Stock Exchange are Fauji Fertilizer Company (FFC) and Hub Power Company (HUBC). Both companies are backed by strong groups, financially sound and are recession proof. However, the stock price charts shown below exhibit wild swings divergent to the actual financial performance of the company during certain periods (see circles on the charts). Therefore, it proves the point that financial performance (fundamentals) alone does not guarantee positive return on investment and overall market environment (sentiment or investor perception) does affect the price.

Fauji Fertilizer Company

Hub Power Company

Does that means, investment in stocks is a bad idea or is this loser’s game? The answer is NO. However, there are certain pre-requisites. For example, to become a doctor, one needs to study every part of the human body to understand its working. To become a successful investor, one needs to have proper knowledge of fundamental and technical analysis because both are necessary to understand the working of stock market and interestingly both disciplines are intertwined.

Hardcore technical analysts may not like my idea of joining both disciplines together but, I firmly believe, fundamental analysis provides basis for the prices to move and technical analysis catches those swings. Price alone cannot move unless there are reasons for it. One may not bother to find or agree with the rational of price move but it is wrong to assume that it went up because RSI was oversold or it crossed a certain average. Price, for the sake of breakout, cannot move from one place to another. Events create swings.

Though price fluctuates daily, fundamentals do not change so often and so are long term trends. A case in point is The Resource Group (TRG) and Muslim Commercial Bank (MCB). The fundamentals of TRG are weak so is the long term trend. The fundamentals of MCB are good and price is showing a consistent uptrend (see charts). See the behavior of price and 52 weeks moving average. In fact, technical analysis is the shadow of fundamental analysis. Technical analysts should be grateful to fellow fundamental analysts who provide fodder to the price swings. God forbid, if all the fundamental analysts go on strike or resign en masse what will happen to the technical analysts?

Muslim Commercial Bank

The Resource Group

In my view, to become a successful investor, one needs to study the general market environment (politics, economic factors such as inflation, interest rates etc) and form a list of stocks after taking into account fundamental factors such as product of the company and it’s positioning in the market, pricing power, management integrity, profitability trends, dividend history and ratios such as ROE etc. One must use long term trend detecting tools such as weekly bar charts and 52 weeks moving average to understand the dominant trend and use the short term indicators such as 14 day RSI and MACD to spot entry and exit points within the broad trending framework.

Using one method alone as the basis of investment is a fallacy and best avoided. I understand this issue is debatable and you can share your opinion at this email address: ravikaml@gmail.com

The article was written on 4th January 2012.