Certainly, any trader has heard of fundamental analysis at least once in the past when trying to study the financial markets.
This is because this type of analysis is of great interest to many investors, especially financial institutions, hedge funds and banks. Many believe that this type of analysis is only in line with the stock market, but this belief is wrong as this type of analysis can be used in different markets such as the currency, commodity and bond markets.
But it should be noted that how this analysis is used varies according to the type of market in which the investor will trade, and therefore, during this article we will try to provide a definition of fundamental analysis of the most liquid markets, namely currencies and stocks.
Definition of Fundamental Analysis of the Stock Market
Fundamental analysis of the stock market is based on the study of the intrinsic value of a particular asset. Through this type of analysis, investors look at all external factors in order to assess the price of shares.
There are two ways to perform this type of analysis. The first method is called Top-Down (descending approach), while the second method is called Bottom-Up (bottom-up approach).
The top-down approach focuses on all economic variables that may affect the future prices of stocks. Initially, the decision-making process is based on the general economic conditions in the first phase, followed by an analysis of the type of sector before focusing on individual companies within the sector.
Investors start their fundamental analysis from a broad angle and then narrow down the research so that they can give a rating of all stocks within certain sectors that often offer the highest potential for growth.
As for the bottom-up approach, investors start looking at individual companies that have strong fundamentals such as financial statements, sales ratio and net profit after tax (and then analyze the performance of the sector in which they operate, and finally assess the health of the entire economy.
Definition of fundamental analysis of the currency market
The fundamental analysis of the currency market is based on the study of all external factors that may affect currency prices as traders look at the economic situation of a particular country in addition to political and social forces.
In short, you may see a rise in the currency of countries with a good economic outlook, in contrast, the currency of countries with negative economic expectations is likely to fall.
Advantages and disadvantages of fundamental analysis
While fundamental analysis is considered by many as an objective approach to valuing the price of financial assets, it remains in fact a complex method.
It takes so long to complete that dealing with too many accounts and too many financial figures can lead to errors.
In addition, this type of analysis is not suitable for short-term trading because it does not provide an ideal timing for entering fast trades thus depriving the trader of taking advantage of markets with liquidity and high volatility.
Also, fundamental analysis does not help in capital management because it does not provide specific points to enter and exit the market quickly in the event of a trend reversal in order to minimize the loss.
It should also be noted that financial markets are irrational due to changes in investor psychology and emotions.
Often, we see an excessive fear and greed in a trader leading to large fluctuations in the market, for example a stock of a company with strong fundamentals can fall strongly and vice versa, which keeps this analysis vulnerable to negative news beyond expectations that would cancel all previous fundamental accounts.
Advantages and disadvantages of technical analysis
Technical analysis is concerned with the study of market activity in addition to the price and volume of trades, where charts and charts are used to analyze some technical patterns that may be repeated continuously in order to predict the future direction of the price.
Technical analysis is a powerful tool to determine the right time to enter the market and give potential price targets to take profits, as well as exit areas in the event of a trend reversal, especially in the short term.
However, unlike fundamental analysis, which follows a rational approach based on the economic data of companies, the most important criticism of technical analysis remains its inability to prove the validity of some price patterns in an accurate manner because it is simply not possible to say with certainty that the previous results of these patterns will be as accurate as the future patterns that will appear. Also, the entire trading system cannot be programmed for automatic trading because it is difficult to code many price patterns.
In addition, technical analysis tends to be more effective in the short term rather than in the long term. Therefore, traders should use both technical and fundamental analysis together to confirm their investment decisions.
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Forex