Excerpt: Are you new to Forex trading and don’t know what fundamental analysis is? Learn with Forex4you the basic concepts of fundamental analysis in finance.
What does the phrase fundamental analysis in finance mean? This refers to the analysis or evaluation of business financial statements, health; and competitors and markets. When applied to the foreign exchange (Forex) market, the analysis then takes into consideration the overall state of the economy and factors including interest rates, production, earnings, employment, GDP, manufacturing and management. When carrying out an analysis on stock, futures contract, or fiat currencies using fundamental analysis, there are two basic methods you can use; the bottom up and top-down analysis. This term differentiates such analysis from other types of investment analysis, like quantitative analysis and technical analysis. While the fundamental analysis in finance is done using historical and present data, the goal is to make financial predictions. Moreover, there are four other possible reasons for doing a fundamental analysis of finance and they are as follows:
to conduct a company stock valuation and forecast its probable price outcome,
to predict its business performance,
to determine its management and make internal business decisions,
To calculate its credit risk.
All of these factors help in defining a numerical intrinsic value for the security that can be compared with its current price so as to determine whether it is overvalued or undervalued.
Objectives of Fundamental Analysis
As we have earlier mentioned, the purpose of doing an analysis is to determine what financial instrument to buy and at what price. However, there are two basic methods to achieve this, fundamental analysis and technical analysis. The former is often (mistakenly) directly contrasted with the later.
Fundamental analysis maintains that markets may misprice a security in the short run but that the "correct" price will eventually be reached. Profits can be made by trading the mispriced security and then waiting for the market to recognize its "mistake" and reprise the security.
Technical analysis maintains that all information is reflected already in the stock price. Trends 'is your friend' and sentiment changes predate and predict trend changes. Investors' emotional reactions to price movements result in recognizable price chart patterns. Technical analysis does not care what the 'value' of a stock is. Their price predictions are only extrapolations from historical price patterns.
Traders can use one or both methods for stock picking. Fundamental and technical analysis are in competition and an investor must make a choice between them. In fact, when used properly, both can be useful tools for the investor looking for opportunity. For example, many fundamental traders use technical analysis for deciding entry and exit points. On the other hand, technical traders use fundamentals to limit their universe of possible stock to 'good' companies.
The choice of stock analysis is determined by the investor's belief in the different paradigms for "how the stock market works". Fundamental analysis includes:
On the basis of these 3 fundamental analyses, the intrinsic values of the shares are determined. In other words, this is considered as the true value of the share. If the true value is higher than the market price it is recommended to buy the share. If it is equal to the market price, hold the share and if it is less than the market price, sell the shares.