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How to select shares

Six common sense strategies, used by successful investors, to identify
shares with potential
Plus, a basic guide to fundamental and technical analysis

Technology
Administration
and Service Awards
WINNER
Online/Self Invested SIPP
Hargreaves Lansdown

CONTENTS

CONTENTS

pg 3

Introduction
Why pick shares?
What this guide will tell you

pg 4

Part A. Get the idea

Method 1: Economic cycle
Method 2: Big Themes
Method 3: Scuttlebutt
Method 4: Directors dealings
Method 5: Newspapers and magazines
Method 6: Excessive falls
Get the idea - Summary

pg 12

Part B. Analyse the Company

pg 12

Fundamental Analysis
1. Performance (Prot Margin)
2. Sustainability (Gearing)
3. Value (PE Ratio)
Fundamental analysis - Summary

pg 16

Technical Analysis
1. Trends
2. Support/Resistance

pg 19

Fundamental or technical analysis?

pg 19

Conclusion

IMPORTANT INVESTMENT NOTES

All investments should be held for the long term as their value can fall as well as rise, therefore you could get back
less than you invested. Unless otherwise stated investments do not provide the capital guarantees of a deposit
account. Similarly any yields will vary over time, so income is variable and not guaranteed. This is designed as a
guide for information purposes only and is not a personal recommendation. If you are unsure you should seek
advice.
May 2012

02 | HOW TO SELECT SHARES

INTRODUCTION

INTRODUCTION
Why pick shares?
In 2008 the FTSE All Share Index fell 33%. It was
a terrible year for shares. However, in that year
225 of the 570 shares in the FTSE All Share beat
the Index. The share price of three shares,
Telecom Plus, Randgold Resources and BTG,
increased over 50%; pharmaceutical giant
AstraZeneca rose 30%.
In the following year, 2009, the market bounced
back and the FTSE All Share Index increased 25%.

That year 340 of the 570 shares in the FTSE All

Share beat the index, with 100 shares increasing
by over 100%.
The lessons we can draw is that in every year the
overall index can mask the performance of
individual shares. Even in a disastrous year like
2008 there will be some shares that perform
strongly. The challenge for investors is to identify
those shares.

What this guide will tell you

The purpose of this guide is not to say selecting
shares that perform is easy; it is certainly not
without risk. However, it can be a lot easier than
you think.
Success in share investing is not a matter of
having a PhD in mathematics or just looking at
past performance, rather it involves the
application of common sense and a disciplined
approach. This guide aims to tell you how to get
started with this.
Before you go any further you should be fully
aware of the risks of investing in shares. Whilst
there are always shares that outperform the
market, there are also those that significantly
underperform. Risk and reward go hand in hand,
no matter how confident you are about a
particular share, you must be aware that they can
fall in value, and you could get back less than you
originally invested.

Where do you find these companies?

Thats what the first part of this guide is about it
lists six different methods used by successful
investors to identify interesting shares. This is not
an exhaustive list. You can use some, all, or none
of these methods, they are just here to give you
some ideas and a simple starting point.
Having found one or more possible shares to
invest in, you may wish to take a closer look at
each company to see if it will make a good
investment. The second part of this guide explains
how to do this with a set of simple analytical tools.

Lets get started.

When you think about buying shares, but you

dont have a particular share in mind, you need
some ideas for which companies to buy.

HOW TO SELECT SHARES | 03

PART A

PART A. GET THE IDEA

Get the idea

Six methods for nding attractive shares

Method 1. Economic cycle

Over time the economy goes through periods of
growth and periods of contraction. This economic
cycle is natural and has recurred throughout
history. This cycle can be very useful to investors.
However, it should be noted that the economy and
the stock market do not move in tandem. This is
because the stock market is usually seen as
anticipating changes in the economy. If, for
example, the economy is expected to accelerate in
six months time, then investors will buy shares
now they wont wait for this to actually happen.
Therefore, when considering the economic cycle,
investors should take into account that share
prices will generally anticipate changes in the
economy that are expected six to eighteen months
ahead.
The economic cycle allows us to classify shares
into two types:
i). Cyclical shares
Cyclicals are companies whose fortunes are

04 | HOW TO SELECT SHARES

intrinsically linked to the health of the economy,

increasing their profits and dividends in the good
times but suffering in the downturns.
When we have to tighten our belts we decide we
can do without luxury handbags and world
cruises. We postpone buying a car and find that
mortgages are harder to come by.
It is difficult to judge when the market has hit the
bottom but if you get on the bandwagon just as it
starts rolling you can buy in comparatively
cheaply in the hope of selling before the economy
starts to slow.
Bear in mind that in downturns cyclical shares are
not all hit at the same time - for instance, retailers
feel the brunt of reduced consumer spending
immediately; their suppliers and distributors then
feel the knock-on effect as the shops reduce their
orders; makers of components and producers of
raw materials come into the cycle last.

PART A. GET THE IDEA

If you are thinking of investing in cyclical shares,

look for those companies:
with strong balance sheets and little or no debt
that anticipate downturns or react quickly by
reducing staffing levels, cutting poor selling
lines or abandoning unprofitable markets
that do not expand too rapidly in an upswing
and thus avoid overstretching their financial
and management resources
where you believe the fall in the share price has
factored in all the bad news and then some
more
ii). Defensive shares
Defensives are companies that sell pretty much
the same amount of goods or services whatever
the state of the economy. They do not enjoy the
boom times as cyclical shares do but neither are
they set back so badly in tougher times. They are
referred to as defensives because they are seen as
a potential line of defence when share prices are
falling.
The introduction to this guide mentioned that
shares in the pharmaceutical company
AstraZeneca rose 30% in the otherwise dismal
2008. It didnt take a genius to work out that even
in a financial crisis people still need to buy
pharmaceuticals a good example of a defensive
share. It is also a good example of how much of
investing is just common sense.
Of course, no sector is entirely recession-proof.
Supermarkets seem superficially to be immune
from a downturn as we all still have to eat, but we
can switch to cheaper foods and drinks, thus
putting pressure on profit margins. Therefore
defensives can also fall in value too.
One significant difference between the two types

of company is worth noting: defensive shares tend

to have greater visibility of earnings; that is they
have contracts that guarantee revenue for months
or even years to come. Such companies generally
represent more stable investments than those
living hand to mouth.
If you are thinking of investing in defensive
shares, look for those companies:
with good visibility of earnings
selling goods or services that are in continuous
demand
with a good geographic spread of markets
with attractive dividend yields
The following table gives some examples of the
major cyclical and defensive sectors.
Cyclical sectors

Defensive sectors

Aerospace
Automotive
Banks
Construction
Engineering and Industrials
Media
Manufacturing
Mining
Property
Retailing
Travel & Leisure

Food
Beverages
Healthcare
Household goods
Insurance
Pharmaceuticals
Support Services
Tobacco
Water

TIP
When considering shares to buy, bear in mind
the prevailing stage of the economic cycle. In
theory, when the economy is growing strongly,
cyclical shares tend to perform well; while in a
downturn defensive shares should if not
perform strongly at least outperform cyclical
shares.

HOW TO SELECT SHARES | 05

PART A. GET THE IDEA

Method 2. Big Themes

The first method of finding share ideas depended
on the economic cycle; we will now look at a
method that tries to look beyond the mediumterm cycle and focuses on the longer term.
One of the major themes of the 21st Century is
likely to be the continued development of the
emerging economies and the huge expansion of
the middle classes within those countries. This
can lead to many investment ideas. For example,
luxury consumption of cars, fashion, wines and
other items are likely to soar in the emerging
economies leading to strong demand for
companies active in these areas. Other Big
Themes are likely to be the aging population in
developed markets, increasing urbanisation, and
the tasks of feeding the world and powering it.
The following table lists a selection of Big Themes
for the coming century and an example of the
type of company that stands to benefit.
Of course, there will always be a large element of
guesswork with such predictions, but the
investments that do come right can benefit
investors for decades. Within each theme some

companies will thrive while others will fail to take

advantage and get left behind losing money for
their investors. Investments made using Big
Themes thinking should only be made with the
longer term in mind.

Sector

Theme

Company examples

Education

Education is soon to become an integrated, global, digital business with

demand and innovation driven as in so many (other) areas - by the
emerging markets.

Pearson

Pharmaceuticals

Global healthcare spending is set to soar with a combination of people living

longer in developed countries and middle-class consumer populations
growing in emerging markets.

GlaxoSmithKline

Mining

The urbanisation and infrastructure development of China and other

emerging markets is likely to provide strong demand for resources for a
period of many decades.

Rio Tinto

Luxury
consumption

The global middle class is set to expand rapidly as emerging economies

Burberry
become wealthier. As this happens consumption will increase, especially the
discretionary element where brand names are all-important.

Africa

China is investing billions in Africa's resources which will help trade and
economic growth there for decades. But Africa is also growing internally
with a booming middle class that should drive consumption.

06 | HOW TO SELECT SHARES

PZ Cussons

PART A. GET THE IDEA

Method 3. Scuttlebutt
Peter Lynch was a fund manager who believed that
you can turn personal experiences as a consumer
into good investment opportunities. For example,
he liked the doughnuts at Dunkin Donuts and the
beds at a particular motel chain so much that he
bought the shares. It obviously worked for him; he
managed the Fidelity Magellan Fund one of the
most successful funds in history. Lynch said:
Every time you shop in a store, eat a hamburger or
buy new sunglasses you're getting valuable input.
By browsing around you can see what's selling and
what isn't.
This idea of using personal experience to influence
your investing decisions was originally proposed
by Philip Fisher who called the process
scuttlebutt*.
The great thing about scuttlebutt is that all
investors can use it, and their experience can be
just as valid as highly-paid fund managers (who
probably dont get out that much anyway).
Scuttlebutt research is easy. Next time youre in the
high street, see which shops seem to be busy or

those shops that seem rather too quiet and just

generally unattractive. If you take easyJet flights
and find them nearly always full, perhaps the
company is worth looking at. If budgets are biting
and you decide to stay in a little more frequently
and order a Dominos pizza, perhaps others are
doing the same.
Scuttlebutt may seem too easy, but dont dismiss it
often this subjective experience can be more
valuable than the seemingly more objective, but
academic, views of analysts and newspaper
columnists.
Stock market research is often based on historical
performance, but your own experiences can show
you exactly whats happening right now.

TIP
The internet offers great opportunities to extend
the power of scuttlebutt research beyond
personal consumer experience to see feedback
from thousands. Obviously, one must weigh
carefully anything on the internet, but it is
certainly a useful additional tool to research a
companys products or services.

Method 4. Directors dealings

Towards the end of April 2010, after a period
when the shares had been gently falling, a C J
Humphrey, C M Brendish, D A Hurst-Brown and R
Amos all bought shares in IT company Anite. A
few weeks later the shares started climbing and a
year later had doubled in value.
The question is: who are these four
people and what did they know?

Throughout the year there are certain periods

when directors are not allowed to buy and sell
shares in their company because they have access
to certain privileged information (e.g. in the period
just before results are announced) but for the rest
of the year directors can deal in their company
shares just like any other investor. The LSE must be
informed of all such dealings and this information
is then widely disseminated.

We dont know what they knew, but we do know

who they are they were all directors of Anite.

Some investors closely follow the dealings of

directors, in the not unreasonable belief that the

*Scuttlebutt is an old naval term for gossip or rumour. Sailors would talk around the scuttlebutt (water barrel on a ship) and
this would give them a better idea about life on the ship.
HOW TO SELECT SHARES | 07

PART A. GET THE IDEA

dealings. In some cases, such as the chart below,

after a quiet period director buying activity can
signal that something is about to happen. Note:
Past performance is not a guide to future returns.

people who understand a company best are its

own directors.
There are many ways to interpret directors

ANITE PLC (AIE)

78

(p)

73
68
63
58
53
48

Shares bought

43
38
33
28
09
Sep

09
Dec

1
Mar

10
Jun

10
Sep

Dec

10

11
Nov

third quarter results. Seven directors felt the selloff was overdone and invested a combined 11.1m
in the shares. In the following months the shares
recovered most of their losses from that day, and in
March the company released record profits for the
eighth consecutive year.

In other cases, directors buying after a big fall in

the shares can indicate that the directors simply
believe the extent of the fall is unwarranted and
that the company is still sound.
On 9 November 2011 Admiral shares fell over 25%
following a negative reaction to the companys

ADMIRAL (ADM)
1500

(p)

1400
1300

Shares bought

1200
1100
1000
900
800
700
Sep

11

08 | HOW TO SELECT SHARES

Oc t

11

11
Nov

1
Dec

12
Jan

1
Feb

M ar

12

12
Apr

PART A. GET THE IDEA

This can also sometimes be seen market-wide.

In retrospect we can see that after the financial
crisis of 2008 the market bottomed in March 2009
and then bounced back strongly. However, at the
time, in March 2009, it wasnt at all obvious that
that was the bottom it never is obvious at the
time. But an exceptional number of directors
bought shares in their own companies between
January and March 2009. They evidently did not

believe that the level of share prices reflected the

underlying fundamentals of their companies this
was a great signal that shares had been oversold.
Directors dont always get it right. In March 2006
there was a frenzy of excited directors buying
shares in Paragon at a price which turned out to
be a bubble peak for the shares. Their error was
compounded when they tried to double up by
buying on the way down as well.

PARAGON GROUP OF COMPANIES (THE) PLC (PAG)

(p)
800
700
600
500
Shares bought

400
300
200
100
0
May

05

05
Nov

May

06

06
Nov

May

07

07
Nov

May

08

08
Nov

A few guidelines for interpreting directors dealings:

Small deal sizes (e.g. below 2,000) and
regular deals are not considered significant.
Deals can be considered more significant if
there are many directors dealing at the same
time, especially if this includes the finance
director.
While directors buying shares can be seen as
a vote of confidence in the company, the
reverse is not necessarily the case. Large
scale sales of shares by directors can be
viewed as negative by the market, as it can
signal the directors have less faith in the

company, or indeed that they believe the

share price has risen far enough for now.
However, this is not necessarily the whole
picture. A director may sell shares for many
reasons for example, they may want to
raise money to buy a house or pay the
childrens school fees. So it is more difficult
to interpret directors selling deals.

TIP
Directors dealings can sometimes provide
great signals for share price movements. But
remember, the buying signals are more
reliable than the selling signals.

HOW TO SELECT SHARES | 09

PART A. GET THE IDEA

Method 5. Newspapers and magazines

Many investment ideas can be found in the stock
market columns of newspapers, magazines and
online, where theres no shortage of tips, tips, tips.
All this can be useful; however it is wise to bear in
mind a couple of things.
First, if you are investing in shares for growth, then
you make money when you sell the shares (not
when you buy them). Therefore, when you sell is
important. However, if you buy a share solely as a
result of a tip and for no other reason you may
not know when to sell it. Because of this it is
important to only use tips as a starting point for
doing your own research. Having done your own

research you will be better equipped to know when

to sell the shares.
The second thing to be aware of is that when a
share is tipped in the media its price can jump up
immediately, simply due to the increase in buyers,
and may then slip back again as the buying
pressure reduces. This is usually only an issue with
smaller companies who have less liquidity in the
market but it is important to check the price at the
time the tip was released to see what movement
has occurred before you buy; in most cases this
will be quoted in the tip.

Method 6. Excessive falls

On 12 January 2012 shares in technology
company Invensys closed at 227.1p. The
following morning the company released a
statement saying that its profits for the year
would fall 60m short of expectations. The
shares reacted immediately, opening at 168p and
closing the day down 19% on the previous day. A

huge fall in one day.

That is the danger of profit warnings shares can
react extremely sharply. However, it can also be
an opportunity. Take a look at the following chart
of Invensys shares over this period.

INVENSYS PLC (ISYS)

235

(p)

225
215
205
195
185
175
2/11

12/1

10 | HOW TO SELECT SHARES

2/11

22/1

1/12
01/0

1/12
11/0

1/12
21/0

2 / 12
31/0

2 / 12
10/0

As can be seen, just three weeks later the shares

had bounced back to their previous levels. This is
fairly common. The market can over-react to
profit warnings and the shares become over-sold.
The opportunity here was to recognise that the
shares had been greatly over-sold and to buy
them after they had fallen 19% on the day of the
announcement.

SUMMARY

A similar behaviour can also be seen sometimes

when companies announce good results. There is
an old stock market adage which says: buy on the

rumour, sell on the news investors cash in on

good news and their selling forces the price
down, which can then create opportunities for
the nimble and level-headed investor.
This method of selecting shares is not without
danger. Sometimes shares fall for a very good
reason and continue falling. The skill is in finding
companies that are fundamentally sound but
have been over-sold in the short term.

Get the idea

We have listed six dierent methods for nding ideas for shares to buy. None of them is
necessarily better than the others. Investors should be like magpies willing to collect
ideas from anywhere. Hunches are also ne. If you wake up one morning and think
sausage skins! (Devro PLC), go with it.
Once you have got an idea for a share, you may simply go with your hunch and buy, but
you might also want to do some simple research on the company - which is the subject
of the next part of this guide.

HOW TO SELECT SHARES | 11

PART B

PART B. ANALYSE THE COMPANY

Analyse the company

In this second part of the guide we will look at two dierent ways of
analysing companies:
1. Fundamental analysis (which assesses the health of a company
through analysis of the gures in its prot/loss report and balance
sheet).
2.Technical analysis (which analyses the historic behaviour of the
share price).

Fundamental Analysis
When planning to buy a second-hand car, you
might think of three things:
1. Performance. How fast does the car go? How
efficient is it?
2. Reliability. What are the chances of the car
breaking down?
3. Value. Is the seller asking too much?
We are going to look at analysing a company using
the same three criteria (although instead of
reliability, in the case of shares well call it
sustainability). The car-buying analogy is not
perfect, but its good enough to get us started.

1. Performance (Profit Margin)

When analysing a company the first thing we

want to do is to assess whether the company is any
good! Is it making good profits?

TIP
When assessing the profit margin of a company
it is useful to compare it with the margins of
other companies in the same sector.

12 | HOW TO SELECT SHARES

One way to do this is to look at how much profit a

company makes for every 100 of goods or
services it sells. This is called the profit margin
and is defined as:
profit margin =

net profit
sales revenue

The result is usually expressed as a percentage.

The average profit margin for companies in the
FTSE 100 Index is around 17%. Currently Next
has a profit margin of 16%, while Diageo has a
profit margin of 24%. Profit margins do differ
somewhat between sectors; supermarkets tend to
have margins in the single digits, while
pharmaceutical companies can have margins over
30%. Profit margins are not usually calculated for
financial companies.

2. Sustainability (Gearing)

If the company passes the first performance test,

the next criterion to address is sustainability.
There are many ways of looking at this; in this
guide we will focus on the size of a companys
debt. A certain level of debt can be beneficial for a

PART B. ANALYSE THE COMPANY

company, but beyond a certain point there is a

danger of a company being overwhelmed by too
much debt.
To assess debt we will use a measure called
gearinggearing =

total borrowings cash

shareholders equity

Where shareholders equity is the companys total

assets less its liabilities.
Again, the result is usually expressed as a
percentage.
The higher the figure, the more potentially
overstretched the company is. The lower the
figure, the less onerous the interest burden will
be.
Gearing goes in and out of fashion. Running up
debts to gear up the business magnifies profits in
the good years but it has the opposite effect in the
bad years. Thus gearing tends to be popular when
the economic cycle turns upwards but there is a

scramble to reduce debt when the cycle turns

down, especially if interest rates are rising.
There is no set level for gearing, nor even a guide
level at which alarm bells should start ringing,
although you would normally expect gearing to be
less than 100%. However, companies with
particularly high capital costs such as plant hire or
construction groups always have high gearing,
usually above 100%.
Typically, bankers and lenders have liked to see
gearing of no more than 50%. If gearing is above
this level, investors would have to consider
whether a company would have problems
borrowing more money at reasonable rates.

3. Value (PE Ratio)

We may find an attractive company (one that is

profitable and has low debt), but it will not be
useful to us if the shares are priced very high
because many other investors have already bought
the shares. So, now we need to look at value. We
need to assess whether the shares are priced
cheaply or expensively in the market.
HOW TO SELECT SHARES | 13

PART B. ANALYSE THE COMPANY

Imagine you are a billionaire and you are thinking

of buying a whole company for 200m, what sort
of profit would you want to see that company
make annually? Perhaps, 20m. 40m would be
better. But if the company was only making, say,
5m would you still buy the company for 200m?
Perhaps not.
If the company was making a profit of 20m,
youd be paying 10 times (200/20) the annual
profits to buy the company. If the company was
making, say 40m profits, then youd be paying 5
times (200/40). And, if the company was only
making, say, 5m profits youd be paying 40 times
(200/5).
This relationship between the value of the
company in the market and its profits is one of the
most important in share investing and is called
the PE ratio, or just PE in most cases. The formula
is usually expressed as:
PE ratio =

share price
earnings per share

How to calculate the PE ratio

When we come to calculate the PE ratio, the share
price is easy to determine - we just look at the
stock market and see what price the shares are
currently trading at. But we have a choice when it
comes to the figure for earnings per share of using:
Historic earnings these are the actual earnings
reported in the most recent company report
Future earnings these are the forecast earnings
for the coming year
The choice of which earnings figures to use can
have a significant effect on the calculated PE. For
example, at the time of writing the engineering
services company Babcock has a historic PE ratio
of 26 and a forecast PE ratio of 12. The attraction
of the historic ratio PE (i.e. the PE ratio calculated
using historic earnings) is that the earnings figure
is historic fact and easy to find. The PE ratio will
14 | HOW TO SELECT SHARES

also vary depending on the share price. Therefore

it is important to calculate the PE ratio using the
most recent share price. The PE ratio quoted in the
fundamental data of a company will be based on
the share price at the time of the report.
How to use the PE ratio
The PE ratio is useful as it allows us to compare
the market price of a company with those of other
companies, a sector or the stock market as a
whole.
As a general principle, the lower the PE, the

PART B. ANALYSE THE COMPANY

cheaper the shares are but beware, as there may

be a reason why shares are going cheaply.
The average PE for the UK market tends to settle
around 14 but it partly depends on the outlook for
the economy. Many companies, including sound
ones, were down to single figures in the recession
because investors fretted over whether earnings
could be maintained.
PE ratios differ between sectors. For example,
slow growing utility companies usually have low
PE ratios (below 15), while high growth
companies, like technology companies, have high
PE ratios (over 30).

SUMMARY

Investors can use PE ratios to compare shares. For

example, if Sainsbury has a PE ratio of 9 and

Morrisons a PE ratio of 12, one could say that

Sainsbury is undervalued relative to Morrisons (if
one also believes the prospects for both
companies are similar). However, if one believes
that the growth prospects for Morrisons are better
than Sainsbury, then it is a case of trying to
quantify how much better they are and whether
Morrisons deserves a PE ratio 30% higher than
Sainsbury.
Investors looking for share price gains will want to
find fast growing companies. And, fortunately, its
not difficult to find them. The problem is that in
most cases that fast growth will already be
reflected in the high price of the shares (i.e. the
shares will have a high PE ratio). The challenge for
the investor is to find companies whose growth is
not yet fully reflected in the share price.

Fundamental Analysis
In this section we looked at three ratios used in fundamental analysis. In practice, there
are many more ratios that investors can use the three here were chosen because they
are straightforward and accessible.
Criteria

Ratio

Notes

Performance

Prot margin

The higher the better.

Sustainability

Gearing

Gearing can be good when the economy is strong

and dangerous when the economy is weak. Be wary
of very high gearing.

Value

PE ratio

High PE ratios can be justied if a company is growing fast. Investors look for
companies where the PE ratio does not fully reect
the growth prospects.

As investors become more experienced they can use more complex ratios, and those
customised to their particular investing approach.
However, more complex does not always mean better. The key for investors is to use a
disciplined approach that they are comfortable with.

HOW TO SELECT SHARES | 15

1. TRENDS

In this guide we will look at two basic concepts of

technical analysis:

Technical Analysis
Some investors (often called chartists) believe that
an understanding of the past price behaviour of
shares can give a clue to future performance.
Chartists do not believe that all price movements
are random; they believe that prices occasionally
form patterns that can affect how a price will
behave in the future.

1. Trends
2. Support and resistance levels
These can be useful tools but should not be used on
their own. Investors should also concentrate on a
companys future prospects.

1. TRENDS
Share prices rarely move in straight lines a typical share
price chart displays a series of jagged moves.

some lines on this chart to highlight the pattern helps.

Although the price has not been moving in an absolute
straight line, it has been moving steadily in a certain
direction within a fairly tight range. The outside straight
lines drawn on this chart are sometimes called trend lines.

However, in the chart below it doesnt take a huge

imagination to see a pattern: the line moves fairly steadily
from the bottom left of the chart to the top right. Drawing

CARILLION (CLLN)
500

(p)

450
400
350
300
250
200
150
100
50
0
03
Jan

03
Sep

May

04

05
Jan

This pattern lasted for a fairly long time, almost ve years.

Some chartists hope to spot such patterns and will buy
the shares to ride the trend.
A popular saying in these circles is the trend is your
friend. This saying is sometimes extended to the trend
is your frienduntil it ends.

16 | HOW TO SELECT SHARES

Sep

05

May

06

07
Jan

07
Sep

But when does a trend end?

Much work is put in by chartists involving complicated
calculations trying to judge when a trend has ended. At its
simplest, we could say that a trend ends when the share
price breaks decisively through a trend line. The following
chart has extended the period of the chart to January
2009.

1. TRENDS

We can see that

the break through
the trend line in
December 2007
was the decisive
end of the upward
trend, and the
shares fell afterwards.

CARILLION (CLLN)
600

(p)

500
Linear (Series 1)

400
Series 1

300

Series 2

200
100
0
J an

03

Jan

04

Jan

05

J an

06

J an

07

J an

08

J an

09

spot trends and the tactics for exploiting them.

Trading with trends is one of the most popular strategies

for chartists. Whole books have been written on how to

2. SUPPORT/RESISTANCE
this level traders will be tempted to sell (in anticipation of
the price falling away again), and their action of selling
will put downward pressure on the price. Other participants may at least hold o buying the shares near this
level which will lead to weak demand and enable the
price to fall away easily.

Sometimes one can see price levels on a chart through

which the share price seems reluctant to break.

As can be seen, throughout a seven-month period the

share price of United Utilities repeatedly moved up
towards a level around 635p and each time fell away.
After a while such behaviour becomes self-fullling: as
more traders notice that the price failed to break through
this level before, when the price moves again up towards

This level through which the price is reluctant to move is

called a resistance level.

UNITED UTILITIES (UU.)

700

(p)

650
600
550
500
450
400
09
Nov

1
Feb

May

10

Aug

10

10
Nov

1
Feb

May

11

Aug

11

11
Nov

1
Feb

May

12

HOW TO SELECT SHARES | 17

2. SUPPORT/RESISTANCE

A similar thing can also happen below the price. Take a

look at the following chart.

Engineering fell repeatedly to the 1800p level, each time

to bounce up o it. This 1800 level is called a support
level. Again, after a while, such behaviour can become selffullling as more traders notice what is happening.

Over four months, the share price of Spirax-Sarco

SPIRAX-SARCO (SPX)
2050

(p)

2000
1950
1900
1850
1800
1750
1/10
22/1

0
12/1
0 6/

12/1
20/

1
01/1
03/

1/11
17/0

1/11
31/0

14/0

2/11

11
02 /
28 /

The theory is that after such a range has become

established, when the price does eventually break out of
the range, the price can move decisively further in the
same direction.

Sometimes resistance and support levels can form at the

same time and the price can bounce between them in a
range.
For a few months the Yule-Catto share price seemed
unable to break out of the range 148-180p.

In this case in January 2012 the price broke through the

resistance level of 180p and moved quickly higher.

YULE-CATTO (YULC)
(p)
210
200
190
180
170
160
150
140
11
Aug

18 | HOW TO SELECT SHARES

11
Sep

Oct

11

11
Nov

De c

11

Jan

12

FUNDAMENTAL OR TECHNICAL ANALYSIS?

Fundamental or technical analysis?

find out when to invest.

Strict fundamental analysts would never use

charts. For them, squiggly lines have as much to do
with identifying undervalued companies as tea
leaves or chickens entrails. For their part, strict
technical analysts think that fundamental analysis
is simply a waste of time. All the analysis has
already been done and is already reflected in the
prevailing share price.

1. If the price is currently in an uptrend, this can

act as confirmation that now is a good time to
buy.

So, the question is: should you use fundamental or

technical analysis?

2. If the price is currently in a downtrend, you

may prefer to wait until the trend changes.

The answer is either, the choice is yours. There is

no right or wrong. Investors who prefer to take a
longer-term view tend to use fundamental
analysis, while shorter-term investors (and
traders) use technical analysis.

3. If the price is trapped below a resistance level,

and could be there for months, you may decide
to wait until the price has broken up through
that resistance level.

CONCLUSION

Why not do what many investors do and use both?

Use fundamental analysis to identify good
companies and then technical analysis to try and

For example, having identified a good company,

look at the chart:

4. If the price is sitting on a support level this

could give you some confidence that now is a
good time to buy with the price seemingly
unlikely to fall.

The main lessons of this guide are:

1. Be open to investment opportunities everywhere. This guide lists six methods
commonly used by investors, but dont feel constrained to use only these.
2. Having identied an interesting company, do the research. You are far more likely to
succeed if you learn about any company before you invest in it.
3. There is no overriding need to have a methodology for buying shares. If hit and
miss or a pin in the FT Share Price pages works well for you, thats ne. However a
more structured approach should aid performance.
4. The most important attributes of successful investors are common sense and
discipline.
No method of picking shares gives you a guarantee of success every time. However we
hope you are able to pick more winners than losers if you follow, and build on, the
information in this guide.

HOW TO SELECT SHARES | 19

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