Fundamental analysis is an essential tool investors use when deciding their investment schedule, processes, and appetite. Understanding the fundamentals impacting prices in CFD and forex trading helps traders gain more insights and draw predictions for price movements. Warren Buffet, George Soros, and other successful investors are famous examples of traders who leveraged fundamental analysis to build wealth; you’ll learn how this concept works in financial trading.
What Is Fundamental Analysis?
Fundamental analysis is a method of analyzing financial markets by considering various factors, such as political and economic events, which impact the value of the market and assets. It does not just view historical prices but how news, data, and events influence traders’ decisions in the financial markets.
Fundamental analysis is widely used for CFD trading and has proven effective when combined with technical analysis. Have you noticed how the exchange rate fluctuates when certain news hits the market or when some government agency/organization or significant financial institution releases its financial reports? That is an excellent example of the market reacting to fundamental analysis.
Components of Fundamental Analysis
Fundamental analysis is a comprehensive, often complex approach that considers three vital components: economic, industry, and company analysis to determine the actual value of an asset. Unlike technical analysis, which predicts prices based on previous prices, fundamental analysis determines the actual value of stocks, currencies, commodities, etc.
Fundamental analysis uses two approaches: top-down and down-top analyses. The former analyzes fundamental data from the economy to industry and down to the company level, while the latter considers fundamental analysis from the company level to industry and then to the broader economy.
Economic Indicators
Economic indicators are macroeconomic data that indicate the financial state of any country. The GDP, consumer price index (CPI), retail sales, industrial production, ROE indicator, P/E ratio, Beta coefficient — Beta (β), earnings per share (EPS), price/balance ratio — (P/B Ratio), PEG ratio, P/S ratio, dividend payout ratio, and dividend yield are the widely used economic indicators in CFD and forex trading. Fundamental traders use economic indicators to analyze the economy’s health and predict future prices based on the expected bias.
Central bank policies are significant factors that influence the exchange rate. Exchange rates tend to increase when interest rates rise, as the demand for the currency increases due to heightened confidence from investors. High unemployment rates may cause a slump in exchange rates due to lower investors’ confidence.
Central banks play increasingly important roles in stabilizing and growing economies and are crucial to the forex market. Central banks typically meet monthly and release reports and policies to guide exchange rates; financial institutions and investors use the set rate for economic activities.
Geopolitical Events
The political state of a country and region also impacts various markets in diverse ways. In times of political crisis, investors dump fiat currencies and buy precious metals, primarily considered inflation-proof. Favorable political conditions, such as improved trade relationships between countries, typically increase investors’ economic confidence.
Fundamental traders keep abreast of geopolitical events to monitor the intrinsic value of forex, find investment opportunities, and manage risks. Acute geopolitical news can cause sharp volatility spikes in exchange rates with ripple effects across other markets. A great example is the way fallen USD exchange rates impact cryptocurrency prices. Wars, conflicts, tensions, and terrorist activities are critical political events to monitor for fundamental analysis.
Market News
When traders receive news of specific events, they try to anticipate how such events will impact the economy, which usually informs their trading decisions. “Trading the news” describes forex traders executing (or not) trades based on their predicted market reaction. News events cause massive volatility in the forex market and present opportunities for traders to make money. It is also crucial to fundamental trading. Market news includes fundamental data and industry and company-specific news such as appointments, resignations, and other important events that could sway investors.
Best Tools for Fundamental Analysis
An economic calendar helps traders identify and categorize fundamental data and events based on expected impact and allows them access to such data easily. Most brokers and financial platforms provide a comprehensive economic calendar for clients. Statistical tools may also be necessary to manipulate and interpret data. Tradingview and Metatrader4/5 are excellent platforms for fundamental analysis as they provide a range of tools and features for tracking news and other important economic data. Yahoo! Finance is also an ideal platform with real-time market data, opinions from top analysts, and financial reports and press releases of companies globally.
Examples of Fundamental Analysis
Suppose you want to invest in the U.S. Dollar at the current exchange rate; you would look up the price history to know the best time to invest. With fundamental analysis, you could track changes in the U.S. economy by monitoring the GDP, employment data, and interest rate. You could also follow the international news to gauge the tempo of the U.S.-China trade relations, especially recent developments regarding importation.
Fundamental Analysis vs. Technical Analysis
Trading with fundamental analysis may seem complex, especially compared to technical analysis. Make no mistakes; fundamental analysis requires as much skill as technical analysis. In some ways, you may need some arithmetic and statistical knowledge to interpret data and draw conclusions correctly. Ultimately, combining both methods will supercharge your analytical processes and help refine your trading outcomes.
