What is Fundamental Analysis and How Can You Trade Based on it?

What is Fundamental Analysis and How Can You Trade Based on it

What is Fundamental Analysis and How Can You Trade Based on it

We review the most common type of analysis and provide context on how it impacts financial instruments

Fundamental analysis is one of the two types of analysis that traders use in their approach to decipher how different currency pairs, stocks, indexes and commodities behave. The second type is technical and while we’ll be focusing on fundamentals here, it has to be noted that both have their own merits and have won over fans that denounce the other approach.

Far from judging which is the better approach, we’ll be looking into what fundamental analysis brings to the table, what its components are and how they should be studied to provide the most complete picture of a given financial instrument.

First for the distinctions and definition – fundamental analysis looks at the driving forces that govern the buying and selling of money, financial instruments and commodities in the real world. These forces are usually large in scale and are constantly observed, measured and predicted by governments, corporate heads, investors and traders. One thing to note early on is that although all financial instruments are interconnected and influence each other, there are specific things that push only certain types of instruments.

An example of this would be interest rate changes from a country’s central bank. By changing them the respective bank is changing the overall value of its currency in one direction or another in comparison to other countries who have either lower or higher interest rates.

This is why currency traders keep a close eye on rate decisions from the two largest central banks in the world – the ECB in Europe and the Fed in the US – as they influence the two most traded currencies. The Bank of England and the Royal Banks of Canada and Australia are other banks whose decisions are followed by traders who are particularly interested in how they manage their currencies, inflation and unemployment.

What is Fundamental Analysis and How Can You Trade Based on it

The last two are the other most important indicators that influence currencies (but not the only ones). Our economic calendar includes them, as well as all other announcements with the same or smaller significance.

Stocks and indexes can be influenced by changes in currency levels, but more often than not they succumb to news that relates specifically to them. A prime example would be the new product announcements or earnings reports of Apple. Launches of new products or the sharing of the prospects of the company command the attention not only of their clients, but also of investors and traders. The last product launch was largely well received by the fans of the company who registered record orders for the new iPhone, but investors were largely unimpressed and left the price of the stock at the same level.

Quarterly announcements are what stock traders wait for every three months. Companies then release their full records like earnings, revenue, earnings per share, future guidance among others. They provide a reference point for everyone and place them on an equal standing information-wise, making the moments after the data is released one the most volatile times, especially if the information hasn’t been priced in already. These numbers, combined with the performance of competitors, industry developments, prices of commodities, rumours and news all influence the price of stocks and respectively indexes.

Traders delve deep into these numbers and can quite often dig deep into other statistics looking for correlations and possible predictions of future price movements, but the above mentioned remain the most crucial in fundamental analysis. Regardless, there are other traders that completely denounce this type of analysis in favour of the more technical approach which leaves the human (and emotional) part of interpreting data and decision-making on the side. Our next post will be taking a closer look into it and provide pointers on how the two can actually complement each other.

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