You will have to learn a lot of new concepts when you start trading. You might have seen the charts moving and pips ticking, but when you are a trader, you can’t just look at things. Instead, these things have to make sense to you. They always have this section in the news where they talk about the stock market, global economy, trading fundamentals, etc.
If you have always wondered what they are trying to do or achieve with that news, you will find the answers as you read on. The keyword here is fundamental analysis, which is an essential part of trading in any financial market.
You will get a basic understanding of trading with this approach with the help of this beginners guide to fundamental analysis. So let’s begin.
When you are in the market for trading, you have to make sure that your money goes in the right direction. You are in the trading industry to make profits, not lose the money you already have. You are investing your money on various assets by buying and selling their values.
Of course, financial markets are not static like a picture. When you look at a price chart, you are looking at a paused version of the market conditions. More like watching a video on YouTube and stopping it at some point. What if you had to bet on what will happen next in the video?
That’s when you will have to start researching a lot of things to predict the next scenes in the video. That’s exactly what you are doing in the financial market. However, there are multiple methods of trying to find out where the market will go. One method is the technical analysis, and the other one is fundamental analysis.
Fundamental analysis will try to uncover the true inherent value of an asset in the market. What is meant by true inherent value? Well, it is the true worth of the asset rather than the face value. For example, $100 in the US can be compared to Bs.100 of Venezuela.
The face value of the two currency notes might seem the same. However, you can buy a lot more with $100 in Venezuela than you can with Bs.100. What’s the reason? Inflation! In other words, the face value of an asset is not its true value. With fundamental analysis, you are trying to uncover the true value of the asset that you wish to trade.
Everything that you focus on when you are doing a technical analysis is what completely ignore in fundamental analysis. That’s because the followers of the fundamental analysis believe that when you do a technical analysis, you are only looking at the face value of the asset.
In technical analysis, you look at a price chart, you consider the past movements of the value of the asset on the price chart, you take into account all the movements, you apply one of the many methods, and come up with a speculation on whether the price will move up or down.
In fundamental analysis, you look at everything but the price of the asset. You look at the global economy, interest rates, economy of the country from where the asset originates, inflation, etc. before you give any verdict on the true value of the asset.
In addition to the factors stated above, you also have to focus on the business itself to know the value of the asset. Let’s take an example to fully understand the importance of fundamental analysis.
So, you look at the current price of XRP (Ripple) in the cryptocurrency market. You see that the price is stable and has been that way for some days. You use a technical analytical method to know where the price will go in the coming days.
Based on the trends in the past few weeks, you might come up with a conclusion that the price of XRP will go up. Even though it is not true for technical analyses to go this wrong, but let’s assume that for the sake of explaining the concept.
So, your technical analysis of the price charts and movements on the price charts in a particular timeframe tell you that you should buy XRP coins because the price is about to increase. However, you give it a second thought and go for a fundamental analysis.
You look at the global economy, inflation, interest rates, etc. affecting the price of Ripple. While doing this analysis, you find out that the company is currently facing a lawsuit. You then read news from more sources to find out about the latest updates. You discover that the chances of Ripple winning the lawsuit are very thin.
What do you do based on this analysis? Well, you will start looking for some other cryptocurrency that’s more stable and safer than XRP. In other words, you have preferred your judgment based on fundamental analysis of the asset rather than its technical analysis. This is exactly what you do in fundamental analysis.
Now, you have to know at this point that different people have different approaches within fundamental analysis. For example, some people start from the top and consider global economy first, then they look into local economy, interest rates, inflation, etc. to find the value of the asset.
On the other hand, some people use the bottom-up approach in which they start with an analysis of the business first and then move on to other factors like interest rates, inflation, local economy, global economy.
The debate is always on whether you should go with fundamental or technical analysis. The best way to go about this situation is to benefit from both. Should you eat an apple or a banana? Well, how about eating both? Just because one feels better than the other does not mean the other one is unhealthy. You might find fundamental analysis to be more real than technical analysis and vice versa. However, the best speculation comes from a look into both irrespective of the asset that you are about to trade.