What is fundamental analysis?
Fundamental analysis is the study of global economic news and indicators affect financial markets. It covers everything from a company's profits for the year to interest rates. It can range from social change such as a growing middle class in China to essential monetary policy.
The most important thing to remember with fundamental analysis that it all the factors dealt with - interest rates for Forex, consumer demand for commodities and profits for stocks – are almost always already factored into the price when you trade.
For stock market traders and those trading individual indices like the FTSE and Dow Jones, people would look at companies' profits as the main indicator in fundamental analysis. Other factors like the state of the industry or political support (eg tax breaks for certain sectors) could also play their part. Again GDP, inflatioon and interest rates can be of interest to the fundamental analyst here.
Fundamental analysis versus technical analysis
Technical analysis and Fundamental analysis are the two main ways of approaching the financial markets. Fundamental analysts, as we have discussed, will look at economic news and data to decipher what a particular trade is likely to do.
Technical analysts, on the other hand, will look at the price movement of a trade and use this information to make predictions about its future price direction.
Why we are interested in technical analysis
All news is economic news and so the number of variables impacting a single price is limitless. It's simply impossible to wade through all the economic data that comes out each day, never mind each week or month. Trying to do so leads to information overload and paralysis by over-analysis. You would spend your whole life looking at the data and never be able to make a trade.
World events – wars, supply shortages, profits etc, are already factored into price. And most importantly all of this data is visible and available to all. Everyone and his dog knows that the Chinese are driving global car demand. That was factored into prices long ago.
Fundamental analysts would argue that economic data will result in the market doing what's it's supposed to. And they are right, it does sometimes. But it doesn't do it often enough. All too frequently the market – ie, the crowd – reacts in the exact opposite way to what the fundamentals ought to suggest.
You can use fundamentals to trade. In fact, you should be aware of basic economic indicators if you are trading the markets as it simply helps to get a picture of the markets and how they interact. But that is the limit of it.
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