The below guide is designed to educate new traders on the building blocks of fundamental analysis as well as provide more detailed instruction and insight for more advanced, professional traders. It will also explain the difference between qualitative and quantitative analysis. Once you’ve read the reference materials below, you will have a basic understanding of how to do fundamental analysis using a simple approach to analyzing stock data, using historical fundamental data points, extensive research, and a variety of economic factors. Included in the guide is everything from examples, to tips on how to analyze a stock or asset price. In no time at all, the analyst in you will learn to perform fundamental analysis on your own, then combine it with technical analysis for the most successful trade strategy possible.
Fundamental Analysis Definition
What is Fundamental Analysis? There are many ways to define fundamental analysis, but breaking it down to as simple terms as possible, it is the study of the underlying value of financial assets, using various data points, both qualitative and quantitative. Fundamental analysis definition may differ slightly from trader to trader, depending on the strategies they use, and what their investment research goals may be. It also matters greatly on if the investor or trader is considering stocks, cryptocurrency, forex, or another financial asset.
Fundamental analysis uses both quantitative and qualitative to form the foundation of the study. Fundamental analysis is nothing like technical analysis which involves reviewing price charts and watching for signals from technical analysis indicators and oscillators. Whether it is digging deep into economic issues, reviewing quarterly revenue reports, or considering a product line-up, there are endless factors that impact the price of an asset, and this can all be anticipated by detailed and in-depth research through fundamental analysis.
Now you know the full meaning behind the fundamental analysis definition, and soon, you will be able to regularly put the powerful tool into practice and turn research into profits.
Quantitative and Qualitative Fundamental Analysis
The two most common strategies to perform fundamental analysis are qualitative and quantitative. Both strategies go hand-in-hand for in-depth fundamental analysis. Here are the differences between the two types of fundamental analysis.
Quantitative Fundamental Analysis
Quantitative analysis using actual statistical data, measurements, financial figures, and other forms of quantifiable research. The practice of quantitative analysis can evaluate anything from product sales figures, profit margins, operating expenses, return on assets and more.
Quantitative analysis involves extensive mathematics and numerical analysis, including stochastic calculus, linear algebra, statistics, probabilities, and econometrics. Quantitative analysis can be used to develop algorithmic trading strategies, optimize portfolios, assess liabilities, manage risk, analyze credit, and much more.
Qualitative Fundamental Analysis
Qualitative analysis requires critical thinking and listing to your instincts. Every trader’s take on qualitative analysis will be different. For example, does the company which stocks you are considering have a strong company culture? Is it in an industry that you expect to take off soon? Do you simply have a gut feeling about the product the company is producing?
Those are the type of decisions that go into qualitative analysis, that all the number-crunching and computer data in the world cannot provide. Data that cannot be quantified in any meaningful way falls into this category.
Another example, during a recession, it might be more profitable to trade gold or oil, as volatility in these assets increases, then when the economy is booming, stocks and cryptocurrencies can be more profitable to trade.
Fundamental Analysis Tools
There are a variety of fundamental analysis tools and methods in order to attempt to accurately find the underlying value of a stock or other asset.
- Earnings Per Share. This tool analyzes the profit allocated to each individual company share, and is calculated by dividing the company’s total profit by the total number of company shares. Earnings Per Share = Net income post-tax / Total company shares
- Price to Earnings Ratio. This is what the market will willingly pay for one dollar’s worth of the company’s earnings. Price to Earnings Ratio = Market price of each share / Company earnings per share
- Price to Book Ratio. This looks at how much equity investors are paying per dollar in the asset, and is often called stockholder’s equity. It compares a company’s book value to its current market share. Price to Book Ratio = Stock share price / Book value per share
- Price to Sales Ratio. This tool compares a company’s stock price to its revenue figures, to provide a strong look at the overall company health to gauge asset performance. Price to Sales Ratio = Market cap / Total revenue
Top Down or Bottom Up
Top-down investing is an analytical approach that looks at the overall macro snapshot of the economy, then later looks at the smaller details with a fine tooth comb. In bottom-up analysis, investors first consider the finest details in an asset, then later review the greater economy to understand the bigger picture.
How to Use Fundamental Analysis
At this point in the guide, you can surely see the value of fundamental analysis and why it matters to investors and traders. Next, you’ll learn why it’s necessary, how to apply it to trading, and see some examples of fundamental analysis in action across forex, stocks, commodities, and even cryptocurrencies.
Why Use Fundamental Analysis
Travelers don’t go blindly without a roadmap, nor do doctors perform surgery without decades of experience and training. Why would a trader or investor simply randomly buy an asset, then expect it to perform and provide returns? Consumers even test drive automobiles before buying them – would you not want to know the data behind the automaker’s financial reports before you purchase their stocks?
The idea is foolish. Anyone who wants to make money knows they must first spend time researching what they are investing in, or which assets they choose to trade. Doing so can mean the difference between buying a dud, or buying the next Amazon, Apple, or Bitcoin.
These assets made early investors wealthy beyond their wildest imaginations. Sure, some likely got lucky rolling the dice, but the vast majority of investors or traders learned about the long-term value proposition through fundamental analysis.
How to Trade with Fundamental Analysis
Fundamental analysis is most often associated with investing, but it is equally critical to traders too. Knowing which markets are volatile, and using breaking news, data, quarterly financial results reporting and more to take positions can lead to substantial profits. For example, if a company releases an earnings report that fails to meet investor expectations by a large enough margin, it could cause the stock price to tank as investors second-guess the future of the company’s bottom line, after failing to produce expected profits.
Fundamental Analysis Examples
- Stock Market Fundamental Analysis. When looking at individual stocks, any of the more common fundamental analysis methods have validity, and can be used depending on the investor or trader’s preference. These include price-to-earnings, earnings per share, or return on equity to perform basic quantitative analysis. Qualitative analysis could include reviewing a company’s board of directors, or examining the company’s individual product line. Fundamental analysis on stock indices could include jobless claims, debt, interest rates, and more.
- Forex Fundamental Analysis. Similar analysis of jobless claims, debt, and other political type factors can dramatically influence the prices of forex currencies and their price activity. More qualitative analysis can include looking at government leadership, global trade positioning, military, manufacturing, and much more.
- Commodities Fundamental Analysis. Supply and demand figures are of the utmost importance here, as well as data related to the environment, geo-location, and weather. The production and consumption of whatever commodities are being analyzed weigh heavily on the inherent value of the asset. For example, with travel currently restricted, the demand for oil has fallen. However, when production was cut, oil prices spiked. This is the sort of situation quantitative and qualitative fundamental analysis can assist with.
- Cryptocurrency Fundamental Analysis. Cryptocurrencies are difficult to perform fundamental analysis on, due to their speculative nature and lack of a use-case or in many cases, companies backing them. Take Bitcoin for example. It is a decentralized blockchain network. Because there’s never been anything like this to exist in the past, it is very difficult to price, resulting in wild price volatility. Cryptocurrency investors can still read white papers for qualitative analysis, if the crypto project is backed by a foundation, the team and its developers may be taken into consideration. Other factors such as digital scarcity, or the value being transacted across the network also can apply to fundamental analysis on cryptocurrencies.
Technical Analysis vs Fundamental Analysis
Technical analysis is the practice of studying candlesticks, chart patterns, indicators, oscillators, trading volume, and so much more. Technical analysis is nothing at all like fundamental analysis, however, both come together to provide investors and traders with the full suite of analysis required to be as profitable as possible. And because there are few things more important than one’s money, these tools are especially critical.
It is recommended that all traders considering fundamental analysis in any way also consider learning technical analysis. For example, finding the right asset and doing all of the research in the world will not be profitable if the asset has recently reached an all-time high, or is showing severely overbought conditions on a technical analysis indicator like the RSI. Instead, the investors or traders would wait for the asset’s price to become more attractive and fall to a level at which makes more sense realistically.
Combined with buying downtrend bottoms or when the RSI becomes oversold, it can keep risk to a minimum and maximize overall profit. And aren’t profits what it is all about! Technical analysis requires its own separate guide, along with a unique guide for each major technical analysis indicator such as the Relative Strength Index, the Ichimoku cloud, Williams Alligator, MACD, and many more.
Conclusion: Fundamental Analysis Tips for Traders
After you become well-versed in fundamental analysis and how to apply a top-down or bottom-up approach to research and the differences between qualitative and quantitative analysis, you can begin considering which assets are interesting to you. Then, all that’s left is to try fundamental analysis yourself using the education you’ve received here in this helpful in-depth guide. Putting everything into regular practice ensures no details are ever missed when researching which assets to put your capital behind or add to your portfolio. Using fundamental analysis can lead to a diverse portfolio that is risk averse and high performing.
Fundamental analysis is useful for long-term investors and short-term traders alike, whether they are new to the finance world or are experienced professionals. It is a necessary step before any investments or trades should be made.
Combining solid fundamental analysis know-how with advanced technical analysis techniques and proper risk management strategies can lead to consistently profitable trades, and minimal losses. Technical analysis offers the other most critical tool traders can use to their favor. It provides additional safety if for some reason circumstances suddenly change, or the initial research didn’t lead to successful choices.
For example, the stock market recently reached an all-time high, and the economy was chugging along just fine. Then the coronavirus arrived and caused a major selloff and the economy is facing a recession. Things can change quickly, and stop losses placed at key levels may have prevented life-changing losses. Knowing exactly where to place stop loss orders to protect wealth or understanding where the best buy zones are located is nearly as important as finding the right assets in the first place.