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Introduction to Fundamental Analysis
"Introduction to fundamental analysis: understand the core economic factors, indicators, and strategies that drive financial markets and smarter investment decisions."
Wikilix Team
Educational Content Team
Have you ever considered what causes currencies, stocks, or commodities to rise and fall in value? Price movements don't happen solely because of technical charts or trader psychology; they reflect fundamental, economic forces such as financial data, interest rates, company earnings, and the influence of the government. This is the presence of fundamental analysis.
Fundamental analysis is crucial for traders and investors, as it enables them to comprehend the language of the markets. It allows them to look behind price movements and, frankly, see the forces behind the price movements. The following guide provides an overview of fundamental analysis, including primary analysis tools and how to apply them to inform trading decisions.
Fundamental analysis is the study of factors that impact the economic, financial, and political value of a financial asset. Fundamental analysis considers something more than price charts:
• In stocks: Earnings of the company, balance sheets, and industry health
• In Forex: Interest rate, inflationary pressures, and the general health of the global economy.
• In commodities: The supply of the commodity, demand for the commodity, and geopolitical factors affecting the commodity.
The essence is to determine if the financial asset is either overvalued, undervalued, or perfectly priced.
Fundamental analysis is functional, as it provides context for moves in market prices. A currency price can increase because its country has raised interest rates, a stock might rise because it has produced great earnings, or oil prices might fluctuate because two major oil-producing countries cut production. Traders can make good decisions without guessing why price action occurs when they understand the "why".
1. Economic Indicators
Economic indicators are data releases that show the economic health of the country. Some of the most important economic indicators are:
• GDP (Gross Domestic Product)- overall growth of economic activity.
• Inflation (CPI, PPI)- how fast prices are rising.
• Employment Reports (NFP, jobless claims) - the strength of labor markets.
• Retail Sales- trends in consumer spending.
2. Central Bank Policies
Central Banks represent a key component of the market. Decisions made by central banks regarding interest rates, money supply, and stimulus drive the prices of currencies and assets. Traders pay attention to the Federal Reserve, European Central Bank, and similar meetings closely.
3. Geopolitical Events
Political instability, elections, wars, and trade agreements impact the market overnight. For example, the British pound continued to be affected by Brexit.
4. Corporate Performance (for stocks)
In assessing individual companies, fundamentals should include revenue, EPS (earnings per share), debt levels, and growth potential. Generally, good fundamentals provide a strong base for long-term stock appreciation.
Many traders asked the question; Do I view it from a fundamental or technical perspective? The answer is usually both.
• Fundamental Analysis tells you the why behind the market move
• Technical analysis tells you when to enter and exit.
To exemplify, using Fundamental Analysis, you could find out that the U.SThe dollar will likely appreciate due to increased interest rates, and you would then apply technical analysis to determine when to institute a position.
1. The Top-Down Approach
The top-down starting point will begin with the global economy, and then it'll narrow to regions, industries, and finally, to assets. This is commonly executed in the Forex and international investing markets.
2. The Bottom-Up Approach
In contrast to the top-down approach, this starting point begins with a company or an asset and only considers the global economy afterward. Many stock investors use this method to select shares.
In Forex Trading
Fundamentals such as interest rates, inflation, and GDP growth will heavily affect currency values. For example, say the United States raises interest rates in an effort to keep up with and compensate for rising inflation. There is a higher likelihood that the dollar rises due to capital flows to a higher-interest rate.
In Stock Investing
Investors will examine a company's earnings report, analyze revenue growth, and compare its performance to that of the industry as a whole to determine whether the company is underperforming or undervalued.
In Commodities
Supply and demand will be the driving force for commodities. For example, weather patterns will impact agricultural commodities, driving supply and demand, and some OPEC decisions will have a substantial impact on the price of oil.
• Economic Calendars: Will show upcoming data releases for each market across the globe.
• Central Bank Announcements: Show statements and results from press conferences for each central bank.
• Financial News Outlets: Help provide the bigger picture globally.
• Filings with the SEC: For stock investors, the earnings report, in addition to any SEC documents or statements.
Imagine you are trading the EUR/USD.
First, the U.S. Federal Reserve raises interest rates.
Next, the ECB (European Central Bank) leaves interest rates unchanged.
Higher interest rates will help attract capital to the United States, and the demand for dollars will increase, therefore decreasing the EUR/USD rate.
As shown here, you can conclude fundamentals without looking at a chart; you would know the fundamental forces are leading to dollar parity. From then on, the technical analysis provides the details of the cadence for timing.
• Overreaction to a single event—data released rarely leads to changes in the long-term trend, and sometimes the trend changes over multiple data releases over time.
• Abstracting Fundamentals—When utilizing fundamentals, these should be considered in the context of the overall economy and not as isolated events.
• Analysis Paralysis: In some cases, especially with economic data, the sheer volume of information could lead to confusion and indecision.
• Keep It Simple- consider the key fundamentals using only a few indicators; don't consume all indicators at once.
• Take Your Reasoning and feel for fundamentals into Your Trading. Analyzing data and valuations on the charts should confirm your fundamentals.
• Have a Trading Journal and Include Your Fundamental Analysis. You can look back on the journal to find how your sentiment was correct when fundamentals played a role in your trading.
• Stay patient. The development of fundamental trading skills will take longer than a 1-minute timeframe; in some cases, it may take days or even weeks.
Fundamentals are focused on the story behind the story for each market. Suppose you use fundamental analysis to study economic indicators. In that case, the actions of central banks, the performance and analysis of various corporates, news, and the views of traders and investors provide a clearer vision for value and direction.
This does not mean it will lead to success in a trade. Still, the study of fundamentals and the application toward technical tools and risk management remain helpful in the unpredictable and volatile market.
The more you can answer the whys behind price action, the more prepared you are to encounter the myriad of variables in the complexities of the global financial markets.
Keep building your knowledge with our structured learning path. Each section builds upon the previous one.
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13 min
Reading time
Intermediate
Difficulty
