|Forex fundamental analysis|
Forex fundamental analysis is a forex trading strategy in which the intrinsic value of a security or a currency pair is calculated based on economical methods and financial analyses. Fundamental analysts measure anything that could affect the value of a certain security. These factors include macro-economic features like industrial status or micro-economic features such as the management of a firm.
The final purpose of fundamental analysis is to obtain a number which could be utilized to compare the efficiency of different assets. Using fundamental analysis, investors will be able to determine if the intrinsic value of a security matches its current price on the market or not.
Fundamental analysis concept
Fundamental analysis is carried out with the purpose of comparing a security’s intrinsic value with its current value on the market. In other words, fundamental analysis is capable of finding securities that are not priced accurately. Analysts usually investigate the overall economical status before focusing on a certain company to find its intrinsic value.
Fundamental analysis measures the intrinsic value of a stock in the stock market by taking advantage of general data. For example, an investor is able to evaluate the price of government bonds by analyzing factors such as interest rate and economical state of a country.
In the stock market, fundamental analysis uses profits, revenues, future growth, dividends and other data to obtain a security’s intrinsic value and evaluate its potential for expansion. All data mentioned above are published in financial reports.
Investment and fundamental analysis
An analyst tries to obtain a model to be able to predict a company’s intrinsic value. This value is only an estimate and is obtained only based on the analyst’s opinion.
If an analyst calculates a stock’s value, and this value is greater compared to the current value of the same stock on the stock market, this analyst may encourage investors to buy the shares of this company. On the other hand, if the estimated price is lower than the current price, the analyst may recommend investors to sell this security.
Investors who follow analysts usually act based on these information and expect to gain more profit when they invest on something, because these stocks are the ones that have high potential to grow. Therefore, stocks that do not have higher intrinsic value will gradually descend. These stocks are the first candidates when investors want to sell stocks.
This strategy is the opposing side of technical analysis. In Technical analysis, traders try to anticipate the future movements of the market based on the history of the market.
Qualitative and quantitative fundamental analysis
Fundamental analysis could consist of anything related to the economical status of companies. These analyses include numbers such as the economical growth of a company, but they can also include qualitative information such as management quality.
Different fundamental factors are divided into two categories: qualitative and quantitative. The meaning of these two words is different from their real meaning. In financial markets, we define these two concepts as below:
- Quantitative: Is related to the information that can be obtained using numbers and measurements.
- Qualitative: Is related to the information that indicate the nature and essence of companies.
In this framework, qualitative data are not measurable. These factors could include the quality of a company, popularity of its brand and the level of research and development they carry out. These two set of factors can not replace each other, and they should be analyzed in conjugation.
Intrinsic value concept
One of the most basic assumptions of fundamental analysis is that the current price of a security on the market is different from its real value. The second assumption is that the price obtained from fundamental analysis reflects the real value of that company more accurately.
Analysts usually consider the real value obtained from fundamental analysis as the “intrinsic value”. However, do not forget that the meaning of intrinsic value in stock market is different from its definition in the options market.
For example, imagine that the value of a certain stock is 20 U.S Dollars. After thorough analysis, it is determined that the intrinsic value of this stock is equal to 24 U.S Dollars. Another analyst carries out the same calculation on the same stock, but finds the intrinsic value to be 26 U.S Dollars. Most investors consider the average of these two numbers to be the actual intrinsic value of that certain stock. Investors are often looking for similar opportunities, in which the intrinsic value of a certain security is higher than its current value on the market.
Finally, we reach the third assumption when conducting fundamental analysis. The third assumption is that in long-term, the stock market will follow the fundamental forces of this market and will cause the price of stocks to reach their intrinsic value. The main problem is that there is no guarantee that this will happen soon.
Fundamental analysis critics
Fundamental analysis critics fall withing two groups: technical analysis traders and those who believe in efficient market hypothesis.
Technical analysis is another major strategy for analyzing the market. Simply put, technical analysts base their investments on price movements and traded volume in the market. These investors utilize price charts and other existing technical tools to analyze the market and totally undermine the fundamental factors of the market.
One of the principles of technical analysis is that the level of supply and demand reflects the influence of all news and other fundamental factors. Therefore, price movements of a security offer a more comprehensive vision from the market.
On the other hand, those who believe that markets are efficient, are in disagreement with both fundamental and technical analysts. This hypothesis claims that anticipating future movements of the market, whether you use technical or fundamental analysis, is impossible. Since pricing is carried out efficiently in financial markets, nobody can predict the price movement of a certain market in the long run.
If you want to participate in financial markets as a trader, you will need to choose a forex broker first. Aron Groups Broker offers extensive trading tools including fundamental and technical analysis tools allowing clients to benefit from a wide spectrum of services and participate in over 500 global financial markets.
Written by: Mohsen Mohseni (Aron Groups).