While fundamental analysis is often associated with stock trading, it is also useful in contract for difference (CFD) trading, foreign exchange trading (forex), and short-term trading. It uses financial and economic factors to analyse an asset’s value and make trading projections.
This article at a glance:
- Fundamental analysis is the study of different factors from the economic, political and financial landscape.
- It can be applied to any kind of asset.
- This type of analysis uses qualitative and quantitative information to understand the real value of a given asset.
What is fundamental analysis?
The market’s sensitivity to economic factors such as interest rates, political changes or supply chain issues is widely reported on. In the case of stocks, the company’s state of financial and internal affairs also heavily plays into such market fluctuations. This is the basis of fundamental analysis, which explores how economic, political, and financial factors impact an asset’s values.
The rationale behind fundamental analysis is that an asset’s market price may not always reflect its fair market value. If the fair market value of the asset is higher than its market price, for instance, it is an indication that the asset is undervalued. In this case, the fundamental analyst would recommend to buy. Prices are likely to go higher when the market adjusts, creating an opportunity to sell at a higher price.
Types of fundamental analysis
As we earlier said, fundamental analysis is closely linked to stock trading. To determine real values of different stocks, fundamental analysts will look at data such as companies’ earnings reports. However, this type of analysis is also applicable to other instruments.
For instance, fundamentals for forex include economic and fiscal factors such as interest rates, inflation, economic growth, taxation, and political events. Brexit was a key influence in the fundamental analysis of Sterling around the time. Similarly, supply and demand heavily plays into the fundamental analysis of commodities such as energies or precious metals.
Keeping this in mind, you can include two broad categories of factors into your fundamental analysis – quantitative and qualitative.
Qualitative factors refer to intangible and immeasurable factors that may impact market prices of an asset. Examples of these would include the regulatory outlook for the asset in different countries, any trade agreements that have been signed, the composition of a company’s board of directors, or even the closure of international borders.
Quantitative market analysis involves studying factors that can be measured in numbers. The GDP, inflation rate, interest rate, and financial ratios such as earnings per share, are all examples of quantitative factors that go into fundamental analysis.
Why is fundamental analysis important?
Fundamental analysis helps to reveal the true value of an asset, versus what the market may be quoting. Keep in mind that market prices do not always reflect actual values, and a fundamental analysis of these assets helps to point towards a potential overvaluation or undervaluation.
Fundamental analysis is particularly helpful to long-term traders (such as position traders) who prefer to hold positions over a significant period of time. This is because they are more concerned with the larger outlook of an asset (i.e., its true value over time) than its short-term value, which may fluctuate for various reasons.
Fundamental analysis vs. technical analysis
Fundamental analysis is quite different from technical analysis, both in approach and execution.
The first point of difference is that fundamental analysis is concerned with decoding intrinsic value, whereas technical analysis uses historical prices to predict future prices.
Further, fundamental analysis explores qualitative and quantitative factors from the general economic, financial or political climate. Meanwhile, technical analysis focuses on volume and price data sourced from trading charts, and analysed using technical indicators.
These differences don’t make one more valuable than the other. Depending on your approach to trading, and the assets you wish to trade, you can use either or even both to aid your trading decisions.
Make fundamental analysis a part of your trading strategies, and start trading today. You can even test your trading strategies through a risk-free demo account. By taking an analysis-backed approach, you can ensure the overall health of your strategies as well as your trading portfolio.
This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. INFINOX is not authorised to provide investment advice. No opinion given in the material constitutes a recommendation by INFINOX or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.