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Fundamental Analysis: Everything A Trader Needs to Know

Updated: Jan 21, 2023

Fundamental analysis is sometimes viewed as the 'white-collar', 'advanced' research method investors use to make better-informed decisions. After all, almost every institutional investment firm deploys some form of fundamental analysis in weird and beautiful ways.

But, in reality, fundamental analysis is more than just fancy statistics mixed with economics. It is an essential investigative method that can be applied to all financial markets. Whether you're a beginner trading from home or a professional managing other people's money, it's hard to imagine a world where neither uses some form of fundamentals to succeed.

As the name suggests, the word 'fundamental' describes the most important, necessary, and essential foundations upon which all other analyses are built.

Originally derived from the Latin word 'Fundare' (to found), fundamentals should be viewed as the starting point for any endeavour. And for traders, the first step in a healthy investment strategy.

Fundamental analysis - everything a trader needs to succeed.

This is what I'll cover:

What is Fundamental Analysis?

Fundamental analysis describes the core aspects of what makes an asset valuable, usually considering financial and economic factors in markets. It is one of the most thorough and comprehensive research levels that lend investors confidence in their 'buy' or 'sell' decisions.

A great way to remember fundamental analysis is to relate it to decisions we each make in everyday life.

For example, if you are looking to purchase a car, you may consider multiple factors that describe the car's quality and ability to meet its designed purpose. One may account for the number of seats, the quality of paintwork, mechanical efficiency, engine power and many, many other factors.

Those are the fundamentals of a car, the things that make the car 'good' or 'bad' at its intended job.

Then, it would be sensible to compare those fundamentals to other vehicles, historical iterations of the same vehicle, and finally, its price, to see if it's worth buying or not. That's the art of fundamental analysis.

I would go as far as to say everybody conducts fundamental analysis in their daily routines, from choosing what toothpaste they prefer to deciding what forex pair is the best to trade.

The Importance Of Fundamental Analysis In Trading

The importance of fundamental analysis lies within its ability to uncover the intrinsic value of an asset or item. Simply, it informs investors whether something, like a stock or forex pair, is undervalued or overvalued, pathing the way to an educated investment decision.

Fundamental analysis in forex helps investors find strong and weak currencies; in stocks, it helps investors find high-quality businesses with growth potential.

From every aspect, fundamental analysis is one of the best forecasting tools in a trader's toolbox by a mile.

Types of Fundamental Analysis

Fundamental analysis usually falls into two main categories in the financial markets: top-down or bottom-up. They are both different angles to approach the same system.

Working our way from top to bottom, this fundamental analysis system is split into:

  • Global 'big-picture' - macroeconomics analysis

  • Sectors and industries - microeconomic analysis

  • Individual companies - financial analysis

1. Top-down analysis

A top-down approach is when an investor looks at the 'big-picture' relationship between global economies.

In general, the methodology is built upon macroeconomic factors, like interest rates, debt, employment, inflation, manufacturing surveys and much more. These factors are then analysed through a systematic process to find interesting trends and beneficial opportunities.

Investors will then take advantage of their macroeconomic analysis by profiting from currencies, bonds and indices trades.

Top-down fundamental analysis is the go-to choice of many professional forex traders and investment firms due to its ability to successfully forecast market trends.

2. Bottom-up analysis

Bottom-up analysis, on the other hand, is where investors take a narrower view, looking at a specific company's financial performance and discovering its value in comparison to the market.

Investors will hone in on very specific metrics, including return on capital employed (ROCE) [1], earnings, profits, branding and market share.

"It is preferred to buy a wonderful company at a fair price, rather than a fair company at wonderful price" - Warren Buffett, Chairperson of Berkshire Hathaway

Generally, the bottom-up analysis is suitable for investing in stocks and commercial bonds, where discovering the intrinsic value versus the current traded market price is the goal of the game.

How Does Fundamental Analysis Work?

Although a broad area of study, fundamental analysis generally involves either a systematic or discretionary process across a wide range of markets and asset classes. Investors would evaluate opportunities based on economic forecasts, fiscal and monetary policy, or even company financial statements.

The information used by investors could be macroeconomic for a broader view or microeconomic for a narrower view. Most of the time, fundamental analysis requires a firm understanding of economics and finance.

The goal of fundamental analysis is to find the intrinsic value of an asset only using its constituent parts, like financial statements for stocks or macro indicators for currencies.