It is important to understand the difference between Fundamental Analysis and Technical Analysis. Simply put, Technical Analysis look at the movement in a stocks price to make predictions, Fundamental Analysis looks at the stock itself and the fundamental factors of the business.
Fundamental Analysis is based on comparing a company’s intrinsic value and market value. In principle, if a company’s intrinsic value is much higher than its market value, investors can infer that the market value should eventually move towards the intrinsic value. Analysts also take into account how global events and the economy might affect the intrinsic value.
Fundamental Analysis can be used in conjunction with Technical Analysis, but generally they are based in different economic schools of thought.
There are two assumptions made in Fundamental Analysis:
- The price on the stock market does not reflect a stock’s real value. This real value is what is referred to as a company’s intrinsic value.
- In the long run, the stock’s market value will begin to reflect the intrinsic value.
Traders using this form of analysis try and estimate companies intrinsic value and how long it will take the intrinsic value to be reflected in the marketplace. They do this by looking at other variables and fundamental events and factors that affect them:
- Natural Events
These can vary from the effects of a natural disaster to annual seasonal fluctuations.
- Political Events
Things like political unrest or a change in leadership can affects the markets.
- Financial Market Sentiment
This is the feeling or tone of the market and the general attitude of investors at the time.
- Release of Economic Data
This can be on a global scale or just company data. Economic data includes everything from a country’s GDP to interest rates, to retail sales and rates of unemployment.
It is important to be aware of what events and factors are likely to affect which markets. But, we must recognise that they are all interlinked – weather patterns might not have a direct effect on currencies, however, a failed harvest due to drought, might affect a countries GDP and therefore the strength of its currency.