Learn the Stock Market Lesson — What is Fundamental Analysis?
Fundamental analysis is the study of economic forces that cause prices to move higher, lower, or stay the same. This method is different from technical analysis, which concentrates on the study of market action. In other words, fundamentalists study the causes of market movement, while technicians study the effect. However, both help you determine the direction that prices are likely to move and it is recommended that you study both methods.
The main idea of fundamental analysis is to find out the company’s intrinsic value by studying qualitative and quantitative factors. Quantitative factors are numerical and can be measured. Such factors include a company’s financial statements. As a fundamentalist, you need to know the company’s expenses, revenues, assets, and liabilities. Questions to keep in mind when studying fundamental analysis are:
-Is the company actually making profit?
-Are the company’s sales increasing?
-Is the company’s revenue growing?
-How much does the company own in debt?
-Are they able to repay its debt?
This means you should be spending a lot of time studying the company’s balance sheets, income statements, and cash flow statements to gain insight on the company’s future performance.
Qualitative factors are based on the quality of the company that are impossible to quantify, such as its quality of management. Other factors to consider are its organization, competition, and regulation (certain regulations might limit potential profits).
How does fundamental analysis compare to technical analysis? Which method should you use?
Many traders believe that technical analysis is a more effective approach because, by definition, the technical approach includes the fundamental. Technicians believe that anything affecting the price, such as fundamentally or psychologically, will be reflected on charts. Thus, they believe that the study of fundamental becomes unnecessary. However, the reverse is not true.
Again, this is not as to say that technical analysis is better than fundamental analysis, or vice versa. Keep in mind that there are times when there are conflicts between the charts and fundamentals, causing discrepancies. Some traders choose to use only one approach and if you don’t want to use both approaches, make sure you try both of them first and find out the one that works better for you.
