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Security analysis is closely linked with portfolio management. The main objective of Security analysis is to appraise the intrinsic value of security. There are two basic approaches to security analysis as follows.
- Fundamental Approach, and
- Technical approach.
The Fundamental Approach of Security Analysis
The Fundamental approach suggests that every Stock has an intrinsic value which should be equal to the present value of the future Stream of income from that stock discounted at an appropriate risk related rate of Interest. Estimate of real worth of a stock is made by considering the earnings potential of firm which depends upon investment environment and factors relating to specific industry, competitiveness, quality of management. Operational efficiency, profitability, capital structure and dividend policy.
Thus, security analysis is done to evaluate the current market value of particular security with the intrinsic or theoretical value. Decisions about buying and selling an individual security depend upon the conferred relative value. Sinc6 this approach is based on relevant facts, it gives true estimate of the value of a security and it is widely use in estimation of security prices
Technical Approach in Security Analysis
The other technique of security analysis is known as Technical Approach. The basic assumption of this approach is that the price of a stock depends on supply and demand in the market place and has little relationship with its intrinsic value. All financial date and market information of a given security is reflected in the market price of a security. Therefore, an attempt is made through charts to identify price movement patterns which predict future movement of the security,
Main tools used in Technical analysis
The main tools used by technical analysis are:
- The Dow Jones theory which asserts that stock prices demonstrate a pattern over four to five years and these patterns are mirrored by indices of stock prices. The theory employs two Dow Jones Averages – the industrial average and the transportation average. If industrial average is rising, then transport average should also rise. Simultaneous price movement is the maid prediction which may show bullish as well as bearish results
- Chart Patterns are used along with Dow Jones Theory to predict the market movements. Various types of charts are used for this purpose.