Unlike technical analysis which focuses on price action, the fundamental analysis looks into underlying financial situation to determine intrinsic values of assets. When asset prices are deemed undervalued, purchases are initiated. On the other hand, overvalued assets are sold.
Fundamental analysis approaches actually differ based on asset types. Binary options brokers such as Ultratrade offer access to multiple asset classes such as stocks, stock indices, commodities, and currencies. Therefore, depending on the asset type traded, it is necessary to take differing approaches to fundamental analysis.
When comes to analyzing stocks, there are three levels of fundamental analysis: company, industry, and macroeconomic. Company analysis involves looking at financial statements, which include the Balance Sheet, Income Statement, and Statement of Cash Flows.
There are various financial ratios such as Price-to- Earnings (P/E), Price-to-Sales (P/S), Price-to Book (P/B), Price-to-Growth (PEG), and the Current Ratio among many others that should be taken into consideration. One way is to compare these ratios to other healthy firms in the industry as well as to see if these ratios are improving or deteriorating.
Investors and traders don’t actually need to compute these figures since these are already provided for free by many financial websites such as Yahoo!Finance. Moreover, there are research reports with opinions about the performances and outlooks for the companies.
In addition to company analysis, the industry it operates in also affects stock price valuation. If the industry is expected to do well, it will likely increase the stock price. On the contrary, deteriorating industry outlook is going to depress values of companies.
Macroeconomic analysis is another part of fundamental analysis. Healthy economic growth in general is likely to lead to increase of stock market valuations, so not only stocks but whole indices are likely to rise. Interest rates can affect valuations as well, with rising interest rates having the biggest effect on interest-sensitive stocks such as those of banks.
Forex prices are strongly affected by economic fundamentals. Changes in interest rates can profoundly affect currency prices. If real interest rates (rates after taking inflation into consideration) increase in a certain country, that’s a positive news for its currency. Higher interest rates mean that more money can be earned in interest, so it attracts flows into that currency. On the other hand, when interest rates decline, that is likely to depress currency’s price.
But, interest rates aren’t all when it comes to currency values. Levels of national debt as well as trade balances affect forex prices. Also, political events can affect values of currencies. In times of worldwide turmoil, US Dollar and Swiss Franc are considered to be safe havens, thus their values increase.
Forex traders follow the news and look at upcoming events. What will be announced in the future is shown in Economic Calendars that brokers such as Ultratrade provide to their clients.
Commodities are to a large degree affected by the laws of supply and demand. If supply outstrips demand, commodity prices drop, and vice versa. Also, natural events such as droughts can impact prices of agricultural commodities, while political events such as instability in the Middle East could lead to increases in energy prices.
Commodities are also affected by changes in the price of US Dollar. If a dollar rises, it will often bring down prices of many commodities. A drop in a dollar will lead to increase in commodity prices. An example of a strong negative correlation is between US Dollar and gold. This is, however, a general rule, so traders need to look at other fundamental and technical factors to complement their analyses.
Many traders follow charts and trends to make trading decisions. But, fundamentals should not be ignored. Indeed, combining these two kinds of analysis can result in better trading performance.