Quick Start Guide to Fundamental Analysis
For traders, fundamental analysis is often just that: fundamental. In one way or another, fundamental analysis affects the decisions that most traders make on a daily basis, both when they are looking at short term day trades and longer term investments. Whether or not you ultimately decide to make fundamental analysis a key part of your trading strategies, you should at least have a basic understanding of how this type of analysis works and know where to find more information and advice, should you require it. In this quick guide, we run through the key elements of fundamental analysis, provide a comparison to technical analysis, and outline some ways you can get started today.
What is fundamental analysis?
Fundamental analysis allows traders to assess whether an asset is over, under, or appropriately valued by looking at its financials, competitors, macro/micro market environments, and other factors as required.
The goal of fundamental analysis is to determine a fair market value of a particular asset. With this number in mind, traders can then compare the fair market value to the asset’s current price and decide whether to go long (bet the price will increase over time), go short (bet the price will decrease over time), or opt to stay out of the trade altogether.
There are several different types of fundamental analysis, all of which provide a different view of the particular asset. By piecing together these different views, traders can form an opinion on the ‘big picture’.
Because of the wealth of information available nowadays, however, traders often differ on their perspectives and predictions. While this undoubtedly creates an interesting source of financial news and commentary, it can be confusing for traders (especially those who are yet to form their own intuitions and methods when it comes to assessing fundamentals). For this reason, fundamental analysis is often paired with technical analysis, which, as we will see later, focuses on the asset’s historic market data and trends, such as price, volume, and chart patterns.
Who uses fundamental analysis?
Fundamental analysis is used by a variety of traders, but typically it is those looking at longer term plays or investments who are more concerned with the fundamentals. This is because when you are thinking about an investment for the long-term, you want to understand exactly what you’re investing in and you want to be reassured that you have a relatively stable asset that is well-priced at the time you are going to buy or sell it.
Day traders usually only adopt fundamental analysis as a complement to their technical analyses. For example, a chart may be indicating a strong likelihood of a stock increasing in price, and in trading and investing communities, people might be expecting an upcoming earnings report to show positive signs of company growth. The earnings report counts as fundamental analysis here, and it is used to support the conclusion of the chart pattern, which counts as technical analysis. When these two sources of information are considered together, the trader would likely feel confident in their decision to go long on a stock, anticipating, of course, that the price will increase further and they will be able to make a profit.
Types of fundamental analysis
Fundamental analysis types fall within two broad categories: quantitative and qualitative analysis.
Quantitative fundamental analysis focuses on the numbers behind an asset. Before you look at quantitative fundamental analysis, however, you should know that not all quantitative (or qualitative, for that matter) sources are made equal. Seeking accurate and reliable information should be your top priority when assessing financial data.
Typical quantitative materials include:
- Income statements: Income statements give you a detailed look at a company’s financial performance over a set period of time, with revenue, costs/expenses, and gross profits typically detailed.
- Balance sheets: Balance sheets are similar to income statements, except they are not as detailed. They do, however, give you a good snapshot of a company’s financial health and performance, and can be especially useful in the beginning when comparing several potential assets for trading or investment.
- Cash flow statements: Cash flows are the monies (usually cash amounts) that come in and go out of a business over a determined period of time. Examples of incoming amounts are revenues from sales or loans from a bank, and examples of outgoings are amounts paid for equipment or operational expenses. Cash flow statements give you a sound indication of the growth potential of a business as well as its underlying ability to meet its financial obligations. These statements are particularly important because they are very difficult to alter or otherwise manipulate.
Qualitative fundamental analysis, on the other hand, focuses on broader factors that indicate the health of the company, industry, and market, such as:
- Business model: What is the underlying business model of the stock’s company? What does a cryptocurrency’s whitepaper say about the approach the new asset is taking? What factors typically influence a given ETF? These are the types of questions you need to consider when assessing the business model (or the ‘operational’ model, if it is not strictly a business) of a given asset. Delve into this as much as possible to get a broad view of the thing you are considering trading.
- Examples: reverse engineer a business model from the company website; read the project’s whitepapers; listen to interviews with key staff members; examine social media accounts and online advertising copy; read reviews about the company or project online.
- Competitive landscape: Once you have ascertained the fundamentals of the asset itself, you want to look at direct and indirect competitors. Look for ‘moats’ or strong competitive advantages, which serve to protect a given asset against actions of other companies or the market more broadly. Companies that have robust moats typically can protect themselves against competition in the long-run.
- Examples: use search engines to see which other companies or projects show up in ads and search results for a relevant keyword; look at companies operating in the ‘alternative to’ sections of company websites, or comparison sites; solicit opinions on certain companies or projects and ask people to identify competitors.
- Leadership: The future of any company or crypto project depends on its leadership, so it’s worth assessing the quality of the management as far as you can. While it may be hard to get information on individuals as day to day managers, you can check out employee reviews of companies or projects on sites like Glassdoor, and you can dig around for news articles or social media posts that relate to the individual. Take a look whether a leader has offloaded (sold) a lot of their stock or asset allocation if you can before you make the trade – that will tell you the leadership’s level of confidence in their own asset.
- Examples: read About pages on company or project websites; look for team members in leadership roles on LinkedIn and other social networking sites; listen to interviews given by the founders; check employee satisfaction websites; find articles about the team in the news.
- Industry: Learning how a particular industry works will give you an advantage over those that blindly trade assets without much thought as to the underlying market currents. Look at any available industry reports or statistics, consider the extent of regulation (and how readily organizations can comply with it), and assess sentiment on the industry as a whole to get a picture of the wider context in which the company or project operates.
- Examples: download industry reports; consult statistics and data websites; read industry journals; search for industry news; check government websites for regulation updates; read expert opinions on broad industry issues in the news.
Fundamental analysis versus technical analysis
Fundamental analysis and technical analysis are, in essence, two sides of the same coin. Both methods of research and analysis will help you to make an informed decision about a particular asset, and in that respect, both are necessary if you want to trade confidently. That said, fundamental and technical analysis do two different things, so it’s useful to compare the two against each other.
As mentioned, technical analysis is more focused on an asset’s historic market data and trends, such as price, volume, and chart patterns. In this regard, technical analysis doesn’t really take into account the quantitative or qualitative factors that fundamental analysis does. It’s not that those factors are completely irrelevant in the mind of the trader; it’s more that the trader is choosing to focus on market sentiment as determined by the asset’s price action.
- Typically used in long term investments
- Useful for planning fair market value
- Considers past, present, and future data
- Typically used for trading and investing
- Sources include news, reports, and financials
- Typically used in short term trades
- Useful for planning trade timings
- Considers past data only
- Typically used for trading only
- Sources include charts, pattern formations, and Dow theory
Where to find out more about fundamental analysis
As we’ve already mentioned, not all sources of fundamental information are equal, so you need to be careful when you’re researching a new asset. If you’re looking for other passionate and well-informed traders to help you with your analysis, try Traderverse. Our cutting-edge social ecosystem helps you discover and discuss data, news, reports, and other materials and get expert feedback on your analyses. For more information, sign up at Traderverse.io or join us on our Discord or Telegram group.