Stock Market Analysis Techniques
- Before buying stocks, investors should evaluate the overall stock market.stock market analysis screenshot image by .shock from Fotolia.com
Prior to buying any stocks, the prudent investor will first evaluate the health of the overall stock markets. The importance this will have on the success of a portfolio cannot be stressed enough. Why? According to William O'Neil, founder of "Investor's Business Daily", three out of every four stocks move in the direction of the general market. So by evaluating the overall market and investing along with it, an investor has already tipped the odds in his favor. - The concept of the stock market index was first put into practice by Charles Dow in 1896 when he took the average of the top 12 stocks and combined them into the Dow Jones Industrial Average (DJIA). Today, it contains 30 large-cap stocks that represent various sectors across the markets. Since that time, the Standard & Poor's (S&P) 500 Index (500 top companies) and the Nasdaq 100 Index (100 of the more volatile tech stocks) have been created. These indices should be used daily by investors to get a quick overview of the general markets. By plotting them on charts, investors can instantly spot trend formations.
- Smart investors always follow the actions of the Federal Reserve as it will provide clues about how the markets may move. The Federal Reserve has the responsibility of setting the nation's monetary policy. This means the Fed directly controls the short-term interest rate known as the federal funds rate, which is the rate at which banks can borrow money. Since a large part of investment theory hinges on calculating risk, investments are compared to the risk-free rate of return. When interest rates go up, the safest investments become treasury bills and bonds rather than stocks. Thus, stocks become less attractive and the stock market goes down. When interest rates go down, it has the opposite effect of the markets.
- Throughout the history of the stock market there have been sectors that serve as market leaders. A sector is basically a group of companies that produce the same types of products or the same types of services. For instance, pharmaceutical companies would be in one sector, while oil companies would be in another sector. Virtually every stock that is a part of the leading sectors will perform well. Therefore, after determining that the overall markets are safe for purchasing new stocks, the next step is the find the top performing sectors. This is done by evaluating indices that represent the various industry groups. After pinpointing a half dozen or so sectors that are performing well, individual stocks should be selected from them. However, do not invest in more than one stock in any sector.
