Fundamental Market Analysis: Basics and Principles

What is Fundamental Analysis?

Fundamental analysis is an approach to asset evaluation that relies on studying economic, financial, and social factors that can influence an asset's value. The main goal of this analysis is to determine an asset's fair value and identify undervalued or overvalued positions in the market. This method is used not only in the stock market but also in the analysis of currency pairs, commodities, and cryptocurrencies.

Main Levels of Analysis

• Company Level: Analyzing key company indicators such as revenue, net income, dividend policy, and ratios (P/E, P/B). Special attention is given to assessing competitive advantages, innovation potential, and management structure.
• Industry Level: Studying trends within a specific industry, analyzing supply and demand dynamics, and examining commodity price movements. For example, in the automotive industry, it is essential to consider the demand for electric vehicles, while in IT, the pace of digitalization is crucial.
• Macroeconomic Level: Reviewing global economic indicators such as GDP growth, unemployment rates, inflation, central bank rates, and international trade dynamics. These data provide insights into the general conditions in which companies operate.
• Global Factors: Considering geopolitical events, natural disasters, pandemics, and global shifts such as the transition to green energy or digital transformation.

Fundamental Analysis in Trading

Traders use fundamental analysis to identify long-term opportunities. For instance, in equities, this approach helps uncover companies with sustainable profit growth, innovative products, and leading market positions. In forex trading, fundamental analysis is used to study the effects of central bank decisions, a country's economic stability, and trade agreements.

However, fundamental analysis is less effective for short-term trading due to its long-term focus. Nevertheless, it can be combined with technical analysis to gain a more precise understanding of the market.

Fundamental Analysis and Capital Management

The Role of Capital Management

Effective capital management is a cornerstone of successful trading and investing. Even with accurate forecasts based on fundamental analysis, neglecting risk management can lead to significant losses. Risk control includes methods such as setting stop-loss orders, calculating optimal position sizes, and diversifying assets.

While fundamental analysis helps identify promising assets, following capital management rules, like limiting risk per trade (typically no more than 1-2% of the account), maximizes effectiveness. This minimizes losses and maintains stability, even during periods of high market volatility.

Tips for Beginners

• Learn basic economic indicators: Understanding metrics like GDP, inflation, and interest rates will aid in making informed decisions.
• Combine fundamental and technical analysis: Using technical indicators, such as support and resistance levels, alongside fundamental data strengthens your strategy.
• Focus on risk management: Minimize potential losses by setting stop-losses and properly allocating capital across various assets.
• Practice discipline: Stick to a pre-defined strategy and avoid emotional decisions.

Applying these tips can help traders and investors avoid common mistakes and enhance the effectiveness of their trading practices.

Why is Fundamental Analysis Used Less Often?

Despite its advantages, fundamental analysis is not a universal tool and is less frequently used by traders focused on short-term strategies. This is due to several factors that make it less appealing for day-to-day trading.

Large Market Players

As emphasized by Richard Wyckoff, large institutional investors such as banks and hedge funds have access to exclusive information and advanced analytical tools. They can foresee market changes and take action long before these changes become apparent to retail traders. This creates an information asymmetry, complicating the work of private investors using fundamental analysis.

Challenges of Analysis

Fundamental analysis requires significant resources and time. Traders need to examine corporate reports, financial ratios, macroeconomic indicators, and even the political environment. Moreover, interpreting this data is often complicated by its contradictions or potential distortions. For example, data may be intentionally "polished" to improve a company's image, increasing the risk of erroneous predictions.

The Role of Technical Analysis

Technical analysis is significantly more convenient for traders working with short-term strategies. It allows for immediate evaluation of price movements, volumes, and support and resistance levels, providing clear signals for entering and exiting trades. This makes it particularly useful in high-volatility conditions, where fundamental data often lags in reflecting the current market situation.

Advantages and Disadvantages of Fundamental Analysis

Advantages

• Long-term trend prediction: Fundamental analysis helps identify sustainable market trends that can last for years, providing a strong foundation for successful investments.
• Valuation accuracy: It allows identifying undervalued or overvalued assets, giving traders and investors a competitive edge.
• Deep economic understanding: Analyzing economic processes such as GDP growth, unemployment, and inflation offers insights into the overall market condition.
• Discovering hidden opportunities: Fundamental analysis helps find promising companies and industries at an early stage of growth.

Disadvantages

• Complex data processing: The analysis requires studying large amounts of information, making it a time-consuming process, especially for individual traders.
• Dependence on data quality: Inaccurate or distorted data can lead to incorrect conclusions and poor investment decisions.
• Slow adaptability: Fundamental analysis is less effective for dynamic markets where instant reaction to changes is critical.
• High knowledge requirements: Successful fundamental analysis demands a deep understanding of economics, finance, and industry processes.

Fundamental analysis remains an essential tool for long-term investors aiming to understand the underlying factors influencing the market. However, for short-term traders, it often takes a backseat to more immediate methods like technical analysis.

Why Is Fundamental Analysis Crucial for Long-term Investors?

Fundamental analysis is a primary tool for those focused on long-term investing. It allows the identification of undervalued assets that could experience significant growth in the future. This makes it indispensable for building a portfolio resilient to market fluctuations.

Key Benefits for Long-term Investors:

• Determining intrinsic value: Comparing market price with the real value of an asset helps identify profitable opportunities.
• Assessing financial stability: Analyzing company reports reveals their ability to withstand economic crises.
• Growth forecasting: Examining industry trends and evaluating competitive advantages provide insights into asset prospects.
• Risk reduction: Understanding macroeconomic and global factors aids in minimizing long-term losses.

Long-term investors using fundamental analysis can confidently navigate complex market conditions and maximize the benefits of their investments.

Fundamental Analysis vs Technical Analysis: Which to Choose?

Many traders and investors wonder which analysis method is better: fundamental or technical. In reality, both approaches have their strengths, and combining them often leads to the most successful results.

Differences Between the Approaches:

• Fundamental Analysis: Focuses on long-term investments, studying economic, financial, and industry indicators.
• Technical Analysis: Used for short-term strategies, focusing on charts, patterns, and trading volumes.

When to Use Each Method?

• For long-term investments – fundamental analysis helps identify promising assets.
• For short-term trading – technical analysis enables quick reactions to price changes.
• For complex strategies – combining both methods provides a more comprehensive market understanding.

The choice of method depends on trading goals and the trader's style. However, using them in tandem opens new opportunities for more accurate forecasting.

Common Mistakes to Avoid When Using Fundamental Analysis

Fundamental analysis can be a powerful tool, but only when used correctly. Many traders make mistakes that can lead to poor investment decisions.

Common Mistakes:

• Ignoring current market conditions: Even if an asset appears undervalued, market conditions may not favor its growth in the near term.
• Blind trust in financial reports: Companies may provide skewed data, so it is essential to verify its accuracy.
• Lack of diversification: Focusing on a single asset or industry increases the risk of significant losses.
• Underestimating macroeconomic factors: Global events, such as changes in monetary policy or political instability, can greatly impact the market.

By avoiding these mistakes, traders can use fundamental analysis more effectively and make more confident investment decisions.