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Fundamental analysis (4)

Phillip Konchar

 

Fundamental analysis

Fundamental analysis is the analysis of the economic, social and political forces which may affect the supply and demand of an asset. This type of analysis is used to create an informed view of the value of an asset and not its price. If value and price are materially different then fundamental analysts see an opportunity.

Fundamental traders are assuming the price will eventually trackback to value. The fact fundamental analysts think all information isn’t reflected in the price is what sets them apart from technical analysts.

Top-down and bottom-up analysis

When we say forces we are talking about risks – like the systematic and unsystematic risks we introduced in our Mastering Trading Risk course. The fundamental risks change depending on the asset being analysed. For example, soft commodities might be impacted by long term weather trends whereas a bond’s value will be more impacted by changes in interest rates.

For the markets that reflect the wider aspects of an economy, like currencies or indices, there are well established fundamental risks that traders analyse. This might be unemployment, GDP growth, PMIs, interest rates and so on. Announcements about these big, macro factors are made periodically and a trader can track these via an economic calendar. This is known as top-down fundamental analysis.

If analysing an asset with unsystematic risks, like a company share, then traders will look at risks like management quality, financial results and balance sheet strength. This is known as bottom-up fundamental analysis.

Regardless of how it is done, the fundamental analyst is always seeking to work out the value of the asset.

Key Learning Points
  • Fundamental analysis is the assessment of the factors that influence the supply and demand of an asset.
  • Fundamental analysts are seeking to work out the value of an asset.
  • Value and price are considered separate and the differences, if material, create trading opportunities.
  • Fundamental analysis can be carried out on any asset type.
  • Top-down fundamental analysis looks at big macro risks, like unemployment.
  • Bottom-up fundamental analysis looks at the unsystematic risk factors that feed into a specific asset’s value.

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