- Personal Finance
Fundamental analysis - what it is and how to use it when trading stocks and futures
What is fundamental analysis?
Fundamental analysis for traders is about using news, data releases and other announcements to give you an idea about whether to buy or sell. So, for instance, if you hear that a company has been profitable, you can expect the stock price to move up. Similarly, if you hear that GDP is better than expected, you can expect the country's indices to move up. On the face of it, it sounds like this is the only sensible way to trade.
Problems with relying on fundamental analysis
However, the problem comes when you consider whether the markets are efficient or not. In other words, did other traders already expect the release and so had factored in the right price for the market, that is, has the market already moved to the position it should be at because others had already expected the announcement? Economists and academics alike would argue that the market is indeed efficient and the news, announcement or data release has already been factored into the price - indeed, one topic I will never agree on with a friend of mine is this exact issue!
It's an oft-debated question. Hence, you have probably heard the quote, "The market can stay irrational longer than you can stay solvent." (attributed to John Maynard Keynes). Loosely-speaking, this means that while you might have expected the market to go up based on sound logical reasons, the market continues to drop and drop resulting in you losing a lot of money.
A smarter approach
As you have probably guessed by now, I am primarily a technical trader. This means that I use patterns in the chaos of the charts to help me decide whether to buy or sell. Naturally, I do not trade around data/news releases as shock news would cause the market to spike through any price levels I am watching. Nor do I take trades based on "gossip" about the economy.
My approach, however, is that I do not completely ignore the fundamentals. If there is rumour about a negative announcement, even if there's a good technical set up for a bull trade, I will sit it out. The way I see things, fundamental analysis gives you a general idea for a direction; technical analysis gives you a reasonably precise level to take a trade at.
You can use this checklist to determine whether you should open a position or not. As per above, if the sentiment suggests "buy" but the technical analysis suggests "sell", then stay well away from the market!
Buy or sell?
Fundamental Analysis/Sentiment suggests:
Technical Analysis suggests:
I hope you find this briefing useful. If you have any questions or comments, please feel free to add them below.
Warning: Trading involves the risk of loss. Please consider carefully whether trading is appropriate to your financial situation. Only risk capital should be used when trading. You are at risk of losing more than your initial investment. Past results are not necessarily indicative of future results.