How and when to use fundamental analysis

The two types of fundamental analysis

That’s a basic definition of fundamental analysis and how it’s different from technical analysis. Boring down into the details further, this strategy can be split into two main types of analysis: 

Quantitative analysis

Quantitative fundamental analysis is all the numbers. It’s the things about a company that can be measured statistically. This means you need to look at a company’s financial statements in order to gauge its position in isolation as well as within the market as a whole. 

For example, you can look at a company’s price-earnings ratio (P/E ratio i.e. the current stock price divided by the company’s annual earnings). You can also look at a company’s income, debt and assets owned. Once you’ve got a handle on these metrics, you can compare them to similar companies within the same industry to determine whether the numbers stack up well or not. 

Qualitative analysis 

Qualitative fundamental analysis looks at qualities that can’t be measured statistically. These can be qualities such as public opinion of the company’s brand, how well established a company is, the people on the board of directors (are the public figures, for example), recent media coverage etc. You could call these qualities the intangibles. They’re the things that you can’t measure statistically but they all contribute to a company’s status and, therefore, value. 

Blending both types of fundamental analysis

Both types of fundamental analysis are useful but, in reality, you can’t have one without the other. It’s possible just to focus on the quantitative or the qualitative. However, for the best results, you should use both. 

This is like combining the subjective and the objective or the art and science. You’re using objective statistics in tandem with metrics that are open to interpretation (i.e. subjective). This should, in theory, give you a better overview of an asset and its intrinsic value. 

The order you choose to use the two types of fundamental analysis is up to you. However, professional traders go through one of the following processes: 

• Top-Down Fundamental Analysis: This is where you consider the macroeconomic factors aka the qualitative factors first before you look at the statistics. 
• Bottom-Up Fundamental Analysis: This is where you consider the quantitative statistics first and then look at the macroeconomic factors. 

Things to look for when conducting fundamental analysis 

We’ve outlined the central premise of fundamental analysis and how it aims to determine an asset’s value by considering its core qualities. We’ve also touched on some of the metrics you can use and how they fit into the categories of quantitative and qualitative analysis. The final thing to do before we conclude this guide is to provide a snapshot of things to look for when you’re conducting fundamental analysis. 

You can use fundamental analysis to assess a variety of financial instruments. We’ve used stocks as an example, but you can also use fundamental analysis for forex, bonds, commodities and indices. The fundamentals of this strategy hold true in all instances.  

However, the specific metrics you need to think about change depending on the instrument you’re assessing. So, with this in mind, here are some things to look for when you’re carrying out fundamental analysis on the following: 

Stocks in a Company 

• A company’s revenue and profit
• A company’s debt and liabilities 
• A company’s growth over the years 
• A company’s media presence 
• A company’s growth potential
• The industry a company exists within and its current state/growth potential 

Forex 

• Supply and demand for a particular currency/currency pair 
• A country’s economy and GDP 
• Interest rates 
• Inflation rates 

Bonds (Government and Corporate) 

• Interest rates 
• Economic policies 
• Credit ratings (a country’s/company’s ability to pay back debt – this means the economic/financial state of a country/company is important) 

Indices 

Indices are baskets of securities. In simple terms, this means an index tracks the performance of multiple stocks. Therefore, you can use the same set of metrics to assess indices as you would stocks. However, it’s important to note that you shouldn’t compare stocks to indices in order to draw comparisons. You should only compare one index to another index. 

Commodities 

• Supply and demand of the commodity in question 
• Market reports 
• Political or economic events that can affect supply chains, demand etc. 

Start using fundamental analysis when you trade 

Jumping straight into a live market and attempting to use fundamental analysis isn’t the best idea. Therefore, if you’re going to use this strategy, it’s important to make sure you understand the fundamentals. Once you’re comfortable with the aims of fundamental analysis and how to do it, try using the Saxo demo account. You then have the ability to try out your own analysis and test out your theories with a virtual bankroll. 

Something else you need to accept before you start using fundamental analysis is that nothing is guaranteed. You can assess every part of an asset and come up with what you believe is an accurate value. That’s great and it’s something you should aim for, but unexpected things can and will happen in the markets. 

Therefore, you shouldn’t see fundamental analysis as a road to riches. Predicting how the markets will move is tricky at best. So, if you’re going to use fundamental analysis in trading, just remember that it won’t produce definitive answers and guaranteed returns, but it can help you decide whether an asset is over or undervalued.