If you would like to trade stocks in the medium term – holding positions for anything from a day to a couple of weeks – you will need to conduct slightly more in-depth analysis than that of a shorter time span.
This will involve examining the historical and anticipated performance of the shortlist of companies you have already compiled.
To do this, you will spend time reading their quarterly earnings reports, following the outcome of any shareholder meetings and preparing for any upcoming events such as a product launch or acquisition.
Step 1: gather your information
To compare companies in your shortlist you will need to gather information on the following:
- Use a price chart to follow a company’s share price over the past 12 months and see if it has decreased or increased over that period.
- Compare any movements in the share price of the company you are analysing with moves in the price of the index on which it is listed – this will tell you whether it is outperforming or under performing its sector and/or the overall stock market.
Prior earnings reports
- Collect data on the company’s last full-year earnings report and its last four quarterly reports.
- Examine the company’s profit, sales, debt, price to earnings ratio and any dividends it plans to pay.
- Compare these with figures from a year earlier to see if its performance is weakening or strengthening.
- Pay attention to the company’s own prediction for the coming quarter and year – these will give you an idea of its possible future performance.
- Read comments from the company’s management on why its results were as good or bad as they were and what the company plans to do to rectify or further improve its performance.
- Read summaries of market risks that the company is currently facing and any legal proceedings its is involved in.
Forward looking estimates
- Find out the companies’ own forecast for what earnings, revenue, etc it expects to report in its upcoming earnings release.
- This will give you a view of the company’s own confidence in its future performance, as well as telling you what expectations have already been priced into its shares by other traders.
- When the company actually reports its results, its share price will move if figures are different than what the market expected – up if they’re better, down if they’re worse – so make sure you know exactly when a company’s next earnings report is due.
- Read analyst predictions for a company’s next earnings report – analysts use complex models to determine whether a stock is undervalued or overvalued and can help you gauge market sentiment.
- Be aware however that analysts too can also get their predictions wrong. Also, forecasts by very well known analysts may already be priced into a company’s share price.
Step 2: tie it all together
You should now be left with the following:
- The performance of the company’s shares over a 12-month period, also compared to the index it is listed on.
- Information on its profit, sales, debt, price to earnings ratio and any dividends it plans to pay.
- Comparisons of its most recent trading data with previous periods and with predictions for the coming year.
- Forward estimates of a company’s earnings per share, revenue, net income and general outlook.
- Information on any upcoming key events for the company that could drive its share price.
- Analyst forecasts of how well the company might perform.
Step 3: use historical price charts to build a roadmap
- Look at a price chart of the company’s stock over the past 12 months.
- Look back over your collection of research on the company and pay particular attention to any times that earnings reports were published, predictions were released and announcements were made.
- Compare the two, looking to see how the company’s share price reacted at all these important times – for example, if the company issued results last May that beat analyst expectations, pay attention to how much the share price moved and in which direction.
By mapping important events against historical price data, you have a historical map covering its last 12 months of performance – this will help you build a future roadmap for possible future price moves when similar events occur.
This research will also give you a more in-depth knowledge of what has been driving a company’s share price over the previous 12 months.
Step 4: consider different scenarios
Your next step is to sit down and work out a range of different scenarios that could occur in the future. This will help you respond quickly if such outcomes do materialise.
Ask yourself the following:
- What sort of expectations are priced into the company share price?
- What is the most likely outcome regarding events/news?
- What has the market potentially priced in?
- What would be unexpected?
This will help you understand what expectations have already been priced into the company’s shares. Thinking in advance through a range of possible outcomes – both in line with forecasts and total surprises – will help you form a view on whether they would cause the company’s share price to lift or fall. You are therefore mentally prepared to trade.
Consider the following:
Company A is about to release its quarterly earnings report.
The last earnings report that was issued, stated that its profit was weak, but in line with forecasts made over the prior 12 months. When the last earnings report was released, the share price did not move much, because the expectation of weak profit had already been priced in. It has just issued a negative outlook for the coming year. Following release of this negative announcement, its shares fell 10%.
Overall, analysts are not expecting the new earnings report to be positive and expect weak profit again.
This is what you can deduct:
- The company has forecast weak profit.
- The negative outlook was a new development that had not been fully priced in – this was probably responsible for moving the share price down 10%.
- That negative outlook has, however, now been priced in (by the 10% fall) so there is little reason to believe that its shares will fall further or become very volatile.
From this, you know that if the earnings report comes out better than expected, the share price could increase. This is a scenario that you have built and you know what to do if this scenario happens.
Step 5: technical analysis
After you have completed your analysis of the companies that you wish to trade, go straight to your price charts and use technical analysis to find possible entry and exit points.
In this lesson you have learned that:
- to choose stocks to trade in the medium term, you will need to perform slightly more indepth analysis. This will involve examining the historical and anticipated performance of the shortlist of companies you have already completed.
- first, gather information on each company’s share price performance and prior earnings reports as well as its own earnings forecasts and analysts’ expectations.
- this will give you a moderately detailed collection of research on each company, giving you a rounded view of its performance and prospects.
- next, compare each company’s share price movements over the past 12 months with the dates of any important reports, announcements or events.
- compare the data and see how the share price reacted to certain kinds of news, showing you how much it rose or fell depending on how much better or worse the news was than expectations.
- build a future roadmap for possible future share price moves when similar events occur again.
- work out a range of different scenarios that each company could experience in the future.
- consider how likely each of them is, to what extent it has been priced into each company’s shares, and whether it would likely move each company’s share price up or down.
- if any of these outcomes do materialise in the future you will be mentally prepared and will already have formed a view on whether to buy or sell each company’s shares.
- you can then go straight to your price charts and use technical analysis to find possible entry and exit points for your trade.