Published: 18 January 2021 by Andrew
What is Fundamental Analysis? Dear reader, we welcome you to this new guide of OnlineTradingCourse.net. During the guide we will talk about fundamental analysis and how this discipline can impact the trading activity of any financial operator.
Why did we decide to dedicate an in-depth guide to just the subject of fundamental analysis? Because this type of analysis, together with technical analysis, represents the starting point for achieving any degree of success by trading online.
The truth is that few traders have heard of it and really know what fundamental analysis consists of. But it is precisely because of ignorance of determining factors like this that most traders lose capital. Wanting to trade without knowing fundamental analysis is like climbing a mountain without hands: it is practically impossible.
Given the importance of this indispensable issue, we decided to create a content that explains the basics of this subject in a simple but effective way. Doing fundamental analysis is not impossible and it is not something reserved only for professionals in the trading sector.
Anyone can do it and increase their results in the field of online trading and when we talk about results, we mean profits! This certainly seems to us to be an excellent reason to continue reading the guide. For this we invite you to invest a small part of your precious time on this page. Because the time spent learning something new is always an investment (especially in the trading field where knowledge is power).
Before starting with our discussion, it is important to underline how, thanks to eToro, it is possible to copy, in a completely automatic way, the best traders in the world. In this way it is possible to trade without having to learn fundamental analysis (or any other type of analysis.
Indeed, many novice traders use eToro both to immediately get the same results as the best traders in the world and to learn how to trade (they can watch live what the best are doing).Click here to sign up for free on eToro
What is Fundamental Analysis and how does it work?
In this guide we want to keep the speeches as simple and gradual as possible. We realize that for many readers the concepts of trading, if too many and too technical, can be indigestible. So, let’s start from the ground up, here is a definition of fundamental analysis:
By Fundamental Analysis we mean the discipline that studies the market trend of assets based on macro events and data, but also on any other external factor that may influence the price trend in the future.
From this definition you can immediately say some things:
- Fundamental analysis is a study, so it is a scientific discipline, which proves to be reliable in most cases where it is applied to online trading.
- This kind of analysis basically makes it possible to make forecasts on the financial markets. This does not mean having the power of foresight, but it means being able to estimate with the maximum possible approximation what could happen on a market based on information coming from concrete data.
- By studying any factor that can influence the performance of a market, this discipline allows the trader to make projections on what could be the next market development and therefore it will be possible to study the most adequate and least risky trading strategy below, based on the price movements that can be expected.
Any professional trader makes use of fundamental analysis, without any exception. Perhaps only those who use extreme techniques such as Scalping can afford to ignore fundamental analysis. However, this is only possible because one chooses to operate in the very short term with techniques at the limit. Otherwise, fundamental analysis is always the ideal option.
Fundamental Analysis and Markets: a close relation
As we have detailed in other articles and guides to learn how to invest, traders have 3 basic time choices to trade the markets:
- Short term investments
- Medium term investments
- Long term investments
If for the short term many traders prefer technical analysis (using indicators such as Elliott’s Waves and others) for any other investment time, fundamental analysis remains simply … fundamental! There is certainly no shortage of traders who also prefer it for short-term operations, but in general the fundamental analysis gives its greatest results especially if used to invest in the medium and long term.
For professionals who use it every day, this discipline is an art form. This is because for fundamental analysis to be effective it must be accompanied by the right interpretations. But what does it mean? Doing analysis always has a discretionary component that depends on the interpretation that the trader offers of a specific event or phenomenon.
Giving the correct interpretation of events is the only way in which fundamental analysis can be truly effective. In fact, the cause / effect correlation on the markets is not always immediate. This means that event X will not always lead to consequence Y. For this reason, those who do fundamental analysis must be good at offering the right interpretation of the facts to make the right decision.
Thankfully, in most cases, the annual cyclical events and news that are known to affect markets almost always have the same effect. Even where a beginner may find it difficult to understand what the effects of a given news could be on a given market, there is always the possibility of going to check in the past what happened when that same event occurred.
For this reason, those who use fundamental analysis have an optimistic opinion on online trading.
The role of Macroeconomy
It is no coincidence that fundamental analysis is also known as macroeconomic analysis. These terminologies are used because the studies on the markets that are part of fundamental analysis have almost all to do with macroeconomics.
As reported on Wikipedia: “in economics, macroeconomic theory (or simply macroeconomics) is a branch of political economy which, unlike microeconomics which studies the behavior of individual economic operators, instead studies the economic system at an aggregate level”.
It is therefore a generalist and universal field of study that studies the big to get to the small, that is what happens on the single financial market where the trader is willing to make investments and of which he is required to know the market movers.
In essence, therefore, macroeconomic analyzes determine all the global factors that can impact the demand and supply of a given asset. The price of an asset, in fact, whether it is a stock, a currency or a commodity, is always determined by the law of supply and demand.
For this reason, fundamental analysis is effective on any type of market and financial asset, without any exception. It can be used both to understand what will be the future trends of the largest and most important market in the world which is Forex, and to study, at a more specific level, all the factors that influence the prices of a specific company on the stock exchange, for the purpose to understand whether his shares will appreciate or depreciate.
Fundamental Analysis and Market Correlations
How is it possible to do macroeconomic analysis and really understand what will happen on a certain market? How is it possible that fundamental analysis allows us to make such precise forecasts on market trends? All this is possible because the market is like a great all-encompassing system. A single, perfectly correlated whole.
Especially today in the globalized world in which we live, markets are completely linked to each other. To give an example, it will suffice to recall how the Greek crisis of 2009 threatened to bring down the entire economic system of the European Union with a great domino effect.
But these mechanisms and effects are equally powerful on a global scale as well. Just think of what happened in 2008 with the sub-prime mortgage crisis. That phenomenon that began in the United States of America was leading to a generalized default on a global level. Only with great effort have central banks been able to contain the damage.
The Correlation of the Markets
Correlation is one of the key factors of fundamental analysis. I know deals with the measure of the relationship between two variables. Correlation can be divided into two types:
- It can be positive and in this case the variables move in the same direction
- It can be negative and in this case the variables move in the opposite direction.
In short, it is a proportional or inversely proportional relationship. The “correlation rate” indicates how much the two variables are connected and influence each other. A classic example of correlation is in bonds. Let’s take the case when bond prices and bond yields are inversely correlated.
When bond prices rise, yields fall and vice versa. In this case we speak of a negative correlation between price and yield. Financial markets are full of correlations. And professional investors pay close attention to them. As long as a certain trend lasts, the correlations (positive or negative) between the performance of stocks, currencies and commodities are a reference point for understanding how to move and therefore how to earn.
Professional traders, those who earn the most, are able to intercept before others when some correlations jump and to grasp the emergence of new correlations, new trends that arise before others. Thanks to this ability they can increase profits dramatically. But the interesting aspect is that learning correlations is not difficult, especially since there are some standards.
Fundamental Analysis as Trading mean
As we will see shortly, technical analysis is the counterpart of fundamental analysis and there are traders who lean towards one or the other discipline. Those who choose to set their action on fundamental analysis to be successful in online trading are called fundamentalists.
This figure has always been framed above all within the stock market, or the market where the shares of large companies such as Facebook, Prysmian or Nike are traded. The fundamentalist’s job, therefore, has always been basically to analyze the growth potential of a company to establish the convenience in purchasing its shares.
Here are the 3 main approaches to trading in fundamental analysis:
- MACROECONOMIC CONTEXT ANALYSIS: as we have seen, in this case the assessments are made on a global scale and concern the various main economic areas distributed over the various continents, this way it becomes possible to determine the markets in which to invest.
- SECTORAL ANALYSIS: secondly, there is the sectoral analysis which more specifically concerns the business prospects of a particular economic sector. The analysis in question requires specific knowledge of that particular sector, or in any case a good ability to access sources is required. In this case, the evaluations can go beyond the economic and financial factors because the sectors analyzed can be the most varied (nanotechnologies, biotechnologies, high tech etc.).
- COMPANY EVALUATION: finally, with the technical analysis, as we mentioned earlier, specific analyzes are carried out on individual companies, which is an excellent approach even for the small novice investor. Here it is necessary to analyze public budgets and therefore build solid opinions on what the intrinsic value of a company can be. Once this is done, a comparison is made with the evaluation expressed by the market, this can lead to recognizing the overvaluation or underestimation of a company. This is where investment decisions start.
Invest in the Stock Market with Fundamental Analysis
Here is a small insight into how to invest on your own in the stock market with the support of fundamental analysis. We go into a little more technical details on how these analyzes are carried out, but the novice investor will not have to worry much about the difficulties in making these assessments because very often they are made available ready-made by professionals in the sector.
In the first instance, to invest in equities, the company valuation approach can be used according to the budget indexes which are 3:
- Solidity Index (DEBT / EQUITY): here we are talking about a very important index because it describes the relationship between financial debt and equity. It expresses the company’s dependence on external sources of financing and also the company’s vulnerability to changes in interest rates. In short, this index is able to make people understand what the real strength of a listed company is.
- Profitability Index (ROI= Return on Investment): this is the ratio of operating profit to invested capital. It serves to quantify the ability to generate income with the typical business of the company. This index can be considered satisfactory if it exceeds the cost of borrowing. In this case it is convenient for the company to borrow money to invest it in the core business (leverage).
- Global profitability index (ROE= Return on Equity): ratio between net profit and shareholders’ equity. It expresses the ability to remunerate own capital and is a synthetic indicator of efficiency. It is satisfactory if it exceeds the rate of return of risk-free investments (government bonds).
Read also: Invest in the Stock Market
Economic Indicators for Fundamental Analysis
If originally, therefore, fundamental analysis was considered above all the prerogative of those who operate on the stock market, now the approach has changed because scholars have realized that the AF method can be used in any other market with full success.
Below we are going to deepen the question of economic indicators, or all those parameters that can influence the price of an asset during its market course. Keeping them under control can help you understand the right time to buy or sell currencies, stocks and other financial assets.
In short, economic indicators are nothing more than data and statistics useful for making stock market forecasts on specific time frames. Thanks to them it is possible to extrapolate the growth estimates of a given market for the following months. The information produced by the indicators is exploited by anyone who uses fundamental analysis as their workhorse.
When analyzing a market to understand what type of investment is needed, the best strategy is to compare and put together the results of one or more indicators. If the data of many indicators coincide and all go in the same direction then this is a strong signal that can indicate the future price trend with good accuracy.
On the main economic indicators that we are going to discuss, not only the traders make the decisions, but also the political decision-makers and it is precisely in this way that the economy influences politics and vice versa. This is the fascinating world of macroeconomics and determines the present and the future of governments and nations that cannot ignore economic indicators to make their decisions. Traders must do the same (they can also help with the economic calendar).
GDP: the role of Gross Domestic Product
It was 1971 when the economist Simon Kuznet received the nobel prize for economics. In part, his victory was also due to the invention of a new indicator destined to have a huge impact: GDP or gross domestic product.
GDP plays the fundamental role in quantifying a country’s productivity and its ability to produce wealth. It is therefore not a method of measuring wealth itself, but the ability of a nation to produce it. GDP can be thought of as the market value of all final goods and services produced by a nation.
Thanks to these characteristics, the GDP is also considered as an indicator of the well-being of a nation. This is also because GDP is often accompanied by a comparison with the national public debt, as the gross domestic product is an indicator capable of defining the ability to repay the debt itself.
In general, a state can have a high public debt, but also a high GDP (e.g. United States) without incurring financial danger or insolvency risk: what matters is the relationship and the reciprocal trend of the two quantities , as the GDP in this case represents an index of how much the State is able to restore its public debt through, for example, taxation and related tax revenues.
GDP data is reported 4 times a year and represents the sum of all goods and services produced by a nation during the year. If the GDP does not grow, it is evident that the nation is not growing either and this has an impact on trading because negative data on GDP very often also carry negative trends in markets such as:
- Banking Market
- Stock Market
- Forex Market
Conversely, if GDP is growing, the markets are positively affected and a climate of confidence is generated on the financial stability of a country.
Work: employment data
Data on the performance of the labor market are very important for those involved in online trading. Especially for those who trade on Forex it is essential to know them and understand what kind of impact there could be on the markets of interest. Employment data are important because they too reflect the general trend of a country’s economy or specific sectors of the same.
Read also: Forex Forecast.
The interpretation of a given economy is also done by counting the jobs that are created. You also need to know what percentage of the workforce is actually employed and also the number of people who are actively looking for a job. Finally, the numbers of those who have applied for unemployment benefit must be added to all these data.
The main indicators on the labor market are:
- Unemployment rate: the unemployment rate indices are released once a month and speak of the results of all the surveys carried out by sector scholars who examine the situation of companies and citizens. The unemployment rate is expressed by the number of people who do not have a job but are looking for it. The increase in unemployment must always be seen as a warning that must be put on alert, on the contrary, a decrease in unemployment is always good news.
- Employment rate: this is the other side of unemployment and indicates the number of people who found employment during the previous month.
- Subsidy applications rate: This figure shows how many people have applied for unemployment benefit in the reporting period. This indicator therefore talks about how many people have lost their jobs and need the subsidy to support themselves. When the labor market does not work, this data has a great impact on the markets.
The employment data are very important in fundamental analysis because they allow us to understand in which state the national economy is located, but also the spending and consumption capacity of the people, which in turn affects the state accounts.
On the other hand, when the data indicate an increase in jobs, the data can be taken very positively and thus the growth of the price of a currency or of companies that are in the sector from which the positive employment data comes from can occur.
The Burden of Inflation
Inflation also has an incredible weight in the field of Fundamental Analysis. This is an indicator that can become a real obsession for some countries, given the weight it has on their economy. Central banks, on the other hand, make it the fulcrum of their monetary policies, a reference point to follow capable of guiding their work.
What exactly is inflation? This is the change in relative prices expressed in percentage terms. It is detected in a given reference period and at the lowest point of the supply chain: that is the retail trade, this means that to know it it is necessary to refer to the prices of products and services as they reach the consumer.
To calculate it, we take into consideration the prices of consumer goods. It is therefore a basket developed by experts that generates data on the two main types of inflation:
- Overall: this kind of inflation is the one that takes into consideration the set of standard goods.
- Core: the one that considers the products and services that have the most volatile prices.
Inflation greatly impacts the currency market and the whole real economy. First of all, it impacts supply and demand. When prices tend to rise, demand increases because the consumer wants to secure the given asset before it goes up again in price, in the same way when prices fall there is a tendency to delay the purchase because one is sure to have the economic availability even future and therefore the demand is lowered.
In trading, inflation impacts in the short term, and therefore must be taken into consideration by those who keep their positions open for a short period of time, and even by those who engage in intraday. From this point of view, inflation is composed exactly like a medium-high power market mover. In the immediate future, it has the power to disrupt market trends.
As any forex course explains, inflation is also one of the main drivers of the currency market.
Balance of Payments
We are now talking about balance of payments or the recording of transactions that are carried out by residents of a certain country with respect to the outside world. We are talking about an indicator of pure and simple accounting which aims to detect the transactions that are carried out between the residents of an economy and non-residents in a given period of time.
The balance of payments is made up of two accounts:
- Current account: refers to the counting of goods and services
- Capital account: refers to the purchases and sales of financial and real assets such as stocks, bonds and real estate.
The balance of payments is useful because it helps to determine how the economic flows of a country are going, for example it can help to understand whether a certain nation is attractive from the point of view of investments or not, taking into account the capital that comes from outside.
The trade balance (BOT) is expressed through a simple equation which is the following:
BOT = total exports of country X – the total imports from country X
Surplus can occur on the balance of payments, or that situation in which there are positive data. This means the country in question is more dependent on exports than imports.
At this moment in the world countries such as Canada, Germany or Japan are able to boast a trade balance with surplus. This is because they have healthy economies and can enjoy higher savings rates.
On the other hand, when the balance of payments is in deficit, the accounts go negative. This means that there is a shortage of exports in the given country. However, a negative deficit is not always associated with negative reactions from the markets. Often it can only be due to natural business cycles. It is no coincidence that important countries with enormously expanding economies such as the United States and China have a balance in deficit.
The Public Debt factor
Finally, there is also a mention of public debt as an important factor for fundamental analysis. For years now, when we follow the news there is almost always one relating to the public debt and how much it has increased. But what does all this mean?
When public debt increases this must always be a cause for concern for a government. Especially if we are talking about already heavily indebted countries, the increase in debt can represent a strong sign of economic instability.
This figure represents the total value of the debt accumulated by a state that is financed through the issuance of government bonds. This factor is not to be confused with the “deficit” which instead represents excessive outgoings from the state coffers compared to annual revenues.
The Treaty of the European Union states that every nation should have a debt of no more than 60 percent of its GDP. But this threshold has already been abundantly exceeded by many European nations.
The world of finance and markets is split in two. On the one hand, there are strong supporters who think that the best and most reliable way to trade is to choose fundamental analysis, many others believe that to be successful in trading you have to rely on Technical Analysis.
As we have seen in the course of this guide, fundamental analysis is already in itself a small universe where you can learn and have a lot of useful data to invest. Similarly, technical analysis represents another side of the same coin.
It is impossible to say which approach is better than the other, but perhaps in the end it is also a rather useless dispute.. The important thing is that everyone uses the tactics and analysis strategies that he prefers and that he believes will lead him to the result as often as possible.
According to OnlineTradingCourse.net, the best approach is the one that provides for a balance of the two forms of analysis. The two approaches should be combined and also used in parallel in order to obtain the most reliable data possible and then think about investing.
What is certain is that by implementing the principles of fundamental analysis presented here, for decades there have been traders able to make significant profits and bring home the desired results, thanks to an effective analysis strategy and model.
We conclude by recalling that those in a hurry to start without problems can always use the eToro platform which allows you to automatically copy the best traders in the world. You can sign up for free on eToro by clicking here. There is also the possibility of subscribing to some good forex signals service, but in this case you need to check that the signals generated are really good.
It is a type of analysis that examines fundamental economic factors to make forecasts in the medium and long term.
These are different analyzes. Technical analysis probably gives better results in the short term.
With a little effort, even a beginner can achieve excellent results.
The ideal solution for a beginner trader is to copy, in a completely automatic way, what the best traders in the world do thanks to eToro.