Financial Literacy - Growing your bottom line
Long-term investing strategies

"The management analysis will give you an interpretation of the reason for what's in the report, what the business is like now, and give you some indication of the future -- sometimes they do it too optimistically and sometimes they do it too conservatively because of the fear of litigation and so on," says Penman.

"It's always a place to start. You can add to that impression by looking at more general industry and firm-specific information outside the firm," he says.

To really get a good picture of a company, one should look not just at the last year's earnings reports, but at a five or 10-year history of the company's performance.

"Can they grow sales? What's the profitability of their sales? What earnings do they make from sales? What are their margins? And then it's a question of how much assets they employ to develop those sales. Obviously more assets mean more investment and lower return on investment," says Penman.

Technical analysis
Whereas an indexing strategy might subscribe to the efficient markets hypothesis, and fundamental analysis involves a close look at a company's financials in the context of its industry and the overall economy, technical analysis falls more under the theories of behavioral finance, which factors the human element into market behavior.

Technical analysts use charts to study historical stock prices and trading volume data to gauge investor sentiment as a guide to the prospects of a particular security.

"Basically you're trying to determine the underlying market psychology based on historical price patterns," says Chip Anderson, founder and president of

"If prices have been going up, you can use various techniques to decide if you think the prices are going to continue to go up, or reverse and go down. The ultimate goal is to find stocks that have a particular price pattern that you feel reflects a market psychology that you can use to predict future movements," Anderson says.

Technical analysis consists of three basic components: trends, levels of support and levels of resistance.

Technical analysis jargon demystified
Support level: Support is a price level which a security has trouble breaking through. As the price goes down it is more likely to rebound when it gets in the support range.

Resistance level: Resistance is the opposite of support. As the price goes up, it may encounter a level of resistance that it has trouble breaking through. As the price rises it is more likely to retreat when it gets in the resistance range.

Trend lines: Trend lines are rising or falling levels of support or resistance. They are drawn between at least two lows or highs and then extended onward to represent the expected resistance, in the case of a downward trend, or support, in the case of a rising trend, the price will encounter.

Head and shoulders: The head and shoulders pattern is one among many patterns that investors who use technical analysis can use. This pattern typically signals a reversal, in this case that the price will go down after an upward trend.

Flags and pennants: Pennants are another pattern technical analysts find in their stock charts. They represent a continuation of a previous trend and identify a pause in the action. When investors see a triangular pennant or their rectangular counterparts, a flag, it means that the preceding trend may continue.

Support and resistance are each points where stock prices repeatedly reverse course.


"You're not giving the numbers on the chart any magical power. What you're trying to think about is: Are the people that make up the market going to give any credence to a particular number -- for instance Dow (at) 10,000 or any stock hitting $100?" says Anderson.

"Those are numbers that often will cause people to pause, maybe just for half a second, or they may generate news articles around the world," he says.

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