In the investment world, traders and investors are familiar with one type of analysis, namely fundamental analysis. This is another side to help in making trading and investment decisions.
Fundamental analysis is widely used by forex traders, stock traders. And even hedge funds traders in their efforts to determine investment choices.
Fundamental analysis definition
The definition of fundamental analysis according to Investopedia, is a method of approaching the analysis of an asset or security from the intrinsic value of a security.
The analysis is based on examining economic factors that are essential to an asset, including indicators from micro and macroeconomics, to consumer behavior.
By including economic indicators related to an asset or security, it aims to estimate that an asset or security is undervalued or overvalued. And it will be related to determining an investment or trading option.
Several elements are used in fundamentals such as Return to Equity (ROE), Price to Earnings Ratio (P/E), Earning per share (EPS), etc.
Apart from economic and financial factors, another important point in this type of analysis is to examine the company’s management effectiveness and industry competition. An assessment of this indicator can make a conclusion about the security value of a company’s stock.
Who uses fundamental analysis?
Fundamental analysis is widely used by investor traders in the forex and stock markets. But is also used by large investors to assess the security of a company.
Fundamental analysis is mostly used by traders, especially to determine the quality of long-term investments in various securities and markets.
The reason for fundamental analysis for the long term is that the macroeconomic condition of an asset is determined by the performance that affects it.
In contrast to the typical technical analysis which is more widely used in reviewing short-term investment decisions.
Fundamental analysis explained
In valuing an asset, fundamental analysis will study the conditions that can affect the value or price of the asset.
A simple example is when farmers plant corn if the weather is not favorable for a good harvest, or the crop is attacked by pests, which allows yields to decline. This condition can cause the price of corn to be more expensive because supply is falling while demand remains the same.
There are also investors and traders who take such an analytical approach to determine their decisions in buying or selling assets with the aim of profit.
Is fundamental analysis important?
Most forex traders may prefer a technical analysis approach because they are typically short-term trades. But in the long term, fundamental analysis is also important because it can affect prices in the long run.
For example, war may affect the value of a currency because of its impact on the banking sector.
However, the fundamental analysis also has limitations. Because in the short term, fundamental analysis may not work well, due to real-time price reactions.
However, it is important for traders to follow the latest news to get updated information that may be useful.
Fundamental analysis for investors
For corporate or personal investors, fundamental analysis can be their spearhead in targeting an investment project. Investors will explore all important aspects where when they receive an investment offer they will investigate aspects related to security, market share, and so on.
Although it does not guarantee that the analysis can give the expected results, this method can minimize the possibility of failure or loss.
Tips Warren buffet to invest
Warren Buffet is a great investor in his investments with several steps, and he is one of the great investors that many other investors follow.
- First, determine the shares to be purchased. This is of course by doing fundamental analysis research first.
- The second chooses a familiar asset. He will not make arbitrary investments before getting to know more about the company or investment assets.
- Third, he is confident in his analysis, if not sure, it is better to hold back.
- Fourth, always follow the information related to the selected asset. This is useful for knowing the growth of the investment portfolio.
- Fifth, sell assets at the right time. When you get the profit according to the target, immediately execute it to take the profit.
Fundamental analysis for traders
Some traders may prefer to use technical analysis, but there are also those who like to use fundamental analysis to help them determine long-term investments.
In trading in CFD trading, an asset is traced from the intrinsic factor to the underlying asset. Fundamental analysis will take big data, from price history, company details, management team.
However, forex traders will track news related to the economic indicators of the country in which the currency is traded. Interest rates, inflation, bonds, currency indices, and so on.
Help in investment decision making
This is an important point in fundamental analysis, helping trading decisions. As in the success story of trader George Soros, who made a big profit on black Wednesday in 1992. He predicted high British inflation would weaken the currency, so he borrowed Sterling and bought the Deutschmark and the Franc. And evidently, high British inflation caused the currency to weaken and Soros made a big profit from the event.
What are the methods of fundamental analysis?
There are various methods of fundamental analysis, but they are broadly grouped into two groups, namely quantitative and qualitative.
- Quantitative is information that is displayed based on numbers and amounts.
- While qualitative is more based on the standard of something, not the quantity.
The two groups of methods complement each other and neither one is better, hence usually analysts use them together.
Quantitative data in fundamental analysis, mostly in terms of financial statements, revenue, assets, because in practice it is more difficult to calculate all quantitative data.
While in qualitative data, important information, about the company’s business model, competitive advantage, management, and corporate governance.
Steps of fundamental analysis
Quoting from SFU, how to do fundamental analysis through the five stages of getting started:
- The first is to analyze the market and economic data. Related to companies that issue shares, regarding the resulting production, revenue, strategy, regulatory, and other economic aspects.
- The second step is to analyze the financial statements. It deals with the company’s financial flows, earnings profit, investment, and other financial data.
- The third step is forecasting a reasonable payoff to achieve. Relates to what factors drive profits, as well as factors that underlie forecasting.
- The fourth step is to formulate the asset value. This is an implementation of steps one to four.
- The fifth or final step is to make recommendations. Analysts then provide recommendations to buy, sell or hold.
3 layers of fundamental analysis
In a fundamental analysis of the stock market, there are three important layers, namely:
- Industry analysis. It analyzes industry data from big data and categorizes them into industries in groups, then selects the industry from the highest to the lowest in both consumers and returns.
- Economic analysis. As described earlier, the economic analysis focuses on the financial statements and all information related to the economic data of each company. In forex analysis, usually, this is related to data on GDP, inflation, interest rates, state budget data, deficits, etc.
- Company analysis. Create groups of companies with the highest to lowest ratings from the results of economic analysis and also corporate governance.
What are the factors of fundamental analysis?
In fundamental analysis related to stock investment, several important things to pay attention to include:
- Net profit. This is the net income of the company after-tax, which is an important indicator in fundamental analysis.
- The operating profit ratio, which reflects the company’s profit from all operations, in this calculation has not been deducted by taxes and interest rate changes. A ratio with a high percentage is considered good for the company.
- Profit margins. It is expressed as a percentage. Profit margin describes the profit from each revenue after deducting all costs, for example, a 10% profit margin with revenue of $100 gets net income of $1.
- Return on equity. It analyzes how well the company is using shareholder equity, by measuring how much profit is compared to shareholder equity.
- Price to earning (PE). This describes the share price relative to the company’s earnings calculated from price per share divided by earnings per share.
- Price to book value. This describes the number of company shares against the book value of the company. For example, the company owns 10,000 shares with a price per share of $500, while the company reports on its sheet that it is worth $50 thousand. Book per value of 50 thousand divided by 500 = 5.
- Earnings per share. This analysis calculates the company’s earnings per share. For example, a company has 10 shares, with a reported profit of 1 million, and to pay a dividend of 10 thousand. Then EPS = (1.000.000-10,000/10,000 = 90,000 / 10,000 = 9.
- The yield of a dividend. It analyzes the number of dividends paid to shareholders, a high value reflects good company performance.
Fundamental analysis in forex
In forex traders trade currencies using the underlying foreign currency. Fundamental analysis in forex puts forward the analysis of the currency-issuing country. This relates to many factors from interest rates, inflation, GDP, press releases of economic news, political conditions, and so on.
How to do fundamental analysis forex
In forex fundamental analysis, traders can see from various points of view and then draw a buy-sell or hold investment conclusion.
Some traders use COT data for USD currency analysis, and also the USD index as a reference in determining whether the USD currency weakens or strengthens.
The most widely used way by forex traders in fundamental analysis is to look at the schedule of the economic calendar. There are many sites that provide economic calendar schedules such as Forexfactory, Dailyfx, Investing and even brokers also provide economic calendar schedule data.
By looking at the details of the news whether it is high impact, medium impact, or low impact. By categorizing these groups, traders focus more on high-impact news with the highest probability of influencing the currency.
Does fundamental analysis work?
Not. Fundamental analysis is also similar to other methods of analysis, both technical analysis, and sentiment analysis.
This is because the market is driven by many factors with market players varying with various interests.
All transactions by market participants are then accumulated and move prices from supply and demand anomalies.
Advantage and disadvantage
Pros
Traders and investors benefit from fundamental analysis, especially for long-term trading. In addition, he will have a broader insight into global economic conditions and predict a good asset in the long term accompanied by comprehensive data.
In contrast to the technical analysis used in short-term trading, it is directly related to charts and prices but does not know global conditions that may suddenly be driven by the price.
However, both methods of analysis, have limitations and neither is perfect, most traders use them together.
Cons
The drawback of fundamental analysis is that it requires more data, and not all traders have access to comprehensive information.
In forex, sometimes news after the release but the effect is only temporary or even has no effect at all.
Final thought
The fundamental analysis complements technical analysis for traders and investors.
A professional investor and trader will always follow the latest updates on global economic developments and find assets that have the potential to provide profit.
Note: this article is for informational purposes only and does not constitute investment advice. Forex, CFDs are risky assets. Each investor is responsible for their investment.
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