Unlike technical analysis, which looks at price action and trends to help pinpoint where prices may head to next, fundamental analysts consider all available data to help them to determine the relative value of a market. They then look for discrepancies between the current market price and their own valuation to spot trading opportunities. For example, they may want to go long or buy Apple shares if their own valuation of Apple is higher than its current share price.
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The two most common types of analysis when it comes to the financial markets are technical and fundamental analysis.
In this lesson, you will become better acquainted with fundamental analysis.
Unlike technical analysts, who focus predominantly on price action, trends and patterns to help pinpoint where prices may head to next, fundamental analysts consider all available data to help them to determine the relative value of a market. They then look for discrepancies between the current market price and their own valuation to spot trading opportunities.
For example, let’s imagine you want to buy a car. You’ve seen one you like for $10,000, but you don’t know whether this is a fair price. So you’ll research around on the internet, seek other people's opinion, compare it to prices offered at various car dealerships, and do general background research to assess whether the price is ‘fair’ and whether the car is worth the money.
What you’d be doing in this scenario is essentially fundamental analysis: you'd take into account all the fundamental factors in play to decide whether or not the price reflects the real value of the asset.
Searching for Clues
Fundamental analysts use an array of available data, including corporate earnings reports, geopolitical events, central bank policy, environmental factors and more to help them with their analysis. They search for clues as to the market’s direction in the future.
Such clues can often be found in macroeconomic data, which is why knowing when important data is released is so important to fundamental traders. The markets tend to focus on potentially crucial macroeconomic readings that could affect the market and provide volatility.
Here are some examples of macroeconomic data releases and why they can have an impact on financial markets:
The way in which macroeconomic releases can affect the market depends strongly on the market’s expectations. Generally speaking, the bigger difference between expectation and reality, the bigger the reaction could be. If a market expects a central bank to hike interest rates and the bank does so, the reaction could be ‘priced in’ and it’s business as usual. When a release takes the market by surprise, however, that’s when major volatility can be sparked.
You can keep informed of all fundamental data releases with our comprehensive market calendar. The effect on the market highly depends on the comparison between the actual reading of a macroeconomic reading and the market expectations, where the bigger the difference, the bigger the effect on the market. Each announcement is categorised as either High, Medium, or Low, in terms of its impact and potential to spark market volatility.
Central Banks Run the World
As previously touched upon, one of the most important factors in fundamental analysis is the monetary policy carried out by central banks. Interest rates, open market operations and central bank interventions influence market conditions and are closely monitored by financial analysts and traders. Some of the most influential central banks include the Federal Reserve (US), the Bank of England (UK), the European Central Bank (EU) and the Bank of Japan (Japan).
Let’s look at an example: the US economy rises 3% in Q1 of 2017, while inflation inches to 2.5% on a year-to-year basis. The Fed elects to raise interest rates. Interest rates increase, so traders decide to put their money in the USD, as this could generate a higher return. Such a move could lead to a higher demand for the US dollar, which would drive prices even higher. Please bear in mind that there are multiple factors that can affect market prices, and the previous is just an example for educational purposes.
More Than Just Bankers and Data
Fundamental analysis also considers outside influences that could affect an instrument’s value or price movement. Natural disasters, such as flooding or earthquakes, can also have a major impact on the fundamental strength of an asset. For example, an explosion of a crucial pipeline may lead to a rapid increase in oil prices as the commodity becomes more difficult to transport and to buy. In such a situation, you could go long on Oil using CFDs.
A Different Point of View
This presentation is provided for general information and marketing purposes only. Any opinions, analyses, prices or other content does not constitute investment advice or a recommendation. Any research has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication.
Past performance is not necessarily indicative of future results, and any person acting on this information does so entirely at their own risk. XTB will not accept liability for any loss or damage, including without limitation, any loss of profit, which may arise directly or indirectly from the use of or reliance on such information.
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Fundamental analysis focuses mainly on:
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