Fundamental analysis

What is fundamental analysis, why is it needed and how to carry it out

The movement in the Forex market is set by fundamental factors. These are the key macroeconomic indicators of the state of the national economy, affecting the participants in the Forex market and the level of exchange rates. These are the factors that fundamental analysis studies.

Information about the interest rates of central banks, the economic course of the government, possible changes in the political life of the country, as well as all kinds of rumors and expectations are the most important in fundamental analysis.

Definition

If you, opening a trading platform, want to see the whole market picture as a whole, you need to add fundamental analysis tools to your arsenal. It is based not only on monitoring the schedule, but also on tracking global economic and political events.

A key referendum, a comment by the president or the publication of negative statistics on the country can drastically affect the exchange rate of the national currency.

Economic, political and even seasonal factors are inextricably linked to trading, and their regular study and use to determine future price values ​​is called fundamental analysis.

The purpose of fundamental analysis

Each trader needs to figure out exactly how economic events and indicators affect quotes, and how to use this data to build their own forecasts.

You can often notice that traders, even experienced ones, believe that since they are scalping, opening dozens of quick trades during the day, they do not need to know anything about the global situation. And you don't have to open the Economic Calendar.

However, this is fundamentally wrong: any changes that you did not have time (or did not want) to pay attention to can negatively affect even short-term trading. The purpose of fundamental analysis is to help the trader prepare for unexpected price changes by understanding the reason why it is happening. And it is, as a rule, external.

What events are taken into account when conducting fundamental analysis?
✔️   economic, geopolitical and social phenomena;
✔️  economic outlook and general market sentiment in relation to a particular country;
✔️  natural disasters (extreme weather conditions, earthquakes and hurricanes that cause serious damage);
✔️  wars and periods of conflicts between countries;
✔️  political events (presidential elections, referendums, forums);
✔️  publishing important statistics (economic indicators) by industry or country.

Fundamentals of fundamental analysis

Trading is a game of expectations and global relationships. It is this law that is embedded in the practical foundations of fundamental analysis.

Let's give an example of such a chain of dominoes. Oil prices affect the inflation rate in the region. Inflation changes - traders immediately start waiting for the central bank to change the level of interest rates.

When Brent fell from $ 100 to $ 30 a few years ago, it shocked financial markets. Although with a lag of a couple of months, inflation eased significantly across the world, and key central banks have noticeably changed their course of policy within a few weeks: from a willingness to raise rates, to a pause in their hikes or new programs to support markets.

All this was done to prevent the economies of the largest countries from being embraced by deflation (a steady decline in prices for goods and services), which subsequently runs the risk of triggering an economic depression.

Why is deflation bad? Excessive cheapening of goods leads to a financial deficit, lack of the necessary amount of funds in the economy and holes in the national budget. It turns out that the country is beginning to lack money not only for development, but also to cover vital costs.

Methods

✔️  Comparison
After the publication of economic indicators, traders immediately begin to react to how much the data differs from expectations, and the exchange rate of the national currency is experiencing strong fluctuations.

This is where you can apply the most common method of fundamental analysis. If the published data is strikingly different from those predicted by the world agencies, traders act with lightning speed.

The more the actual value differs from the forecast, the more violent the reaction will be: for example, a wave of closing positions will follow, or vice versa, a massive opening of deals will begin in the direction that seemed to everyone obvious.

✔️  Seasonality
This factor affects the assets of almost all markets, especially the stock market. In the case of stocks, it is not only the period of quarterly reporting of companies that matters, but also the volume of sales “in season” and “out of season”. Thus, some companies receive more revenue in the summer, while others - in the winter, depending on the industry. This affects the amount of dividends paid, the value of shares (volatility) and investor interest in them (liquidity). In cases where seasonal factors play a significant role, various methods have been adopted to eliminate it.

Sales figures of companies and a number of macroeconomic data for the country are compared not only with the previous quarter, but also with the same quarter a year earlier. In addition, for macroeconomics, national agencies use “seasonality” methods that allow you to adjust the data, understanding how much they deviate from the norm for that month or quarter.

In addition, before the Christmas weekend, investors' positions are liquidated and closed on exchanges. This must be taken into account, because in a low-volatility market, such a movement can result in a sharp jump in quotes. To more clearly understand exactly how to behave at a particular time of the year, of course, you should use other methods of fundamental analysis. Seasonality alone is, of course, not enough for making a decision to buy or sell.

Also with other asset categories, from currencies to commodities. For example, the annual rainy season in America suddenly dragged on. Now he is able to ruin the cotton crop: the volume of the available batch will be less than planned, and the prices for it will skyrocket. It turns out that by tracking such factors and conducting analysis in time, it is possible to predict the cost of cotton futures.

✔️  Deduction and induction
Using induction, a trader brings together the indicators of a variety of indicators and news that he has read, and tries on their basis to predict how the price will move in the future. This is how financial analysts work.

Deduction is only relevant to trend trading and is most often included in fundamental stock analysis. Its essence is to draw conclusions from the general to the particular. A very complex technique that often gives an error in the analyst's self-confidence, but with its help it is possible to understand what to do with EURUSD, when, for example, there is an increase in anxiety around the integrity of the eurozone.

✔️  Correlation
It is, rather, a combined method of fundamental analysis at the interface with technical. The essence of the correlation is that when the rate of one asset rises, the price of another, dependent, may rise or fall as well. Previously, all this was calculated by hand, it was laborious and opaque. You can now use correlation indicators such as OverLay Chart and Indcor-Correlation on your trading platforms. 

✔️  Grouping and Summarizing
This is a pro level. When assets are divided into groups according to behavior and characteristics, and then a general index is calculated based on them. So, when analyzing the stock market, you can put together your own macroeconomic indicator, like the Dow Jones, which includes 30 blue-chip stocks.

Collect indices (portfolios) according to your personal criteria and try to apply this analysis method in practice!

The structure of fundamental analysis

Choosing parameters and looking for answers to questions. What asset are you planning to trade on? What currencies are included in the pair (if we are talking about forex) or which companies are included in the index (if we are talking about fundamental analysis of securities)? How long are the deals planned for? For example, if you want to trade intraday, then there is no point in comparing companies' annual reports.

We watch the news. Dow Jones, Investing, FxTeam, TASS, Interfax, RBC, Bloomberg, CNN feed - choose what is convenient for you to get the most prompt data.

We draw conclusions about the current state of the industry and probe the background around the asset. According to news reports, for example, one can understand the level of sentiment for oil or the euro and draw conclusions both regarding the direction of the transaction (Buy-Sell) and regarding the attractiveness of the asset. Well that is if there is no significant news in the Eurozone, and oil is jumping like a roller coaster, then perhaps it is worth paying attention to Brent.

Choosing the time to trade. Set the time frame on the chart that suits your strategy and immediately open the Economic Calendar: this is the main tool for fundamental analysis. See what news for the country you are interested in has already been released, which will be released in the near future and which - tomorrow. It often happens that on the eve of major events, assets already include forecast values ​​in quotes. It is also quite likely that national currencies may "hide" in anticipation of the forthcoming data. By understanding the big picture, you will see why everything is happening on the chart this way and not otherwise.

Analysis stages

✔️  Analysis of the economic situation
As an example, we propose to consider the most liquid and popular EURUSD currency pair. As a rule, this is generally the first financial instrument that traders get to know.

So, we begin the analysis - both the currency and the stock market - with the big picture. There is always enough news from the Eurozone and America to support strong volatility in pairs and stocks. Specifically, EURUSD, as a litmus test of the two strongest regions, is perfect for all trading styles, including scalping and swing.

When planning to open deals on EURUSD, pay attention to the decisions on the monetary policy of the ECB and the Fed. In both cases, the management meets every 6 weeks in order to decide on changes in interest rates, as well as to note changes in the estimates of the economy.

Hearing the official language of the representatives of central banks, newcomers may think that the obvious things were said. However, experienced analysts act here in the role of "translators" into human language, comparing the previous statements of the regulator with the current ones and developing analytical reviews on this matter.

✔️  Industry and company analysis
This stage is included in the fundamental analysis of the stock market. If you are going to trade CFDs on stocks, we recommend that you first of all study the activities of the selected company. Start tracking corporate news, as well as events in the industry in which the company operates: it can be pharmaceuticals, IT, industry, etc.

Fundamental analysis of securities uses indices as the main indicators. Such popular indicators as Dow Jones Industrial Average, Nikkei225, S & P500 include shares of well-known companies in the region. Thus, in order to understand which industry currently dominates the market and is the most attractive for transactions, it makes sense to also follow the changes in the rates of the respective indices.

Be sure to check the Dividend Calendar before trading. It helps determine the beginning and end of the corporate reporting season. Almost every day of this period is full of news on certain companies. The data they publish affect both the value of stocks on the market and the quotes of the indices they are part of.

✔️  Analysis of the value of securities
We will demonstrate this aspect of fundamental analysis of the stock market using the example of Microsoft. In terms of financial indicators that can be found in the public domain (for example, on Investing), this is one of the most stable and richest companies on the market. On financial resources, you can see graphs of growth in total and operating income, as well as their very slight decrease against the backdrop of the coronavirus. All this speaks in favor of the stability of the company and its shares.

You can see from the historical charts and tables that Microsoft securities also showed a global upward trend during 2019, bringing the company's market capitalization closer to $ 1 trillion.

Within a day, week and even month, securities quotes can change both up and down. It depends on the publication of situational data, reports, news and the economic background of the country as a whole. However, the factors of fundamental analysis - revenue growth, tax cuts and strong economic growth in general - played in favor of the market in general and Microsoft's capitalization in particular.

Main data sources

✔️  Financial analytics and news
First of all, determine which events in the stock market and which events in the foreign exchange market you will need to track. For example, not every news from the United States will affect the dollar rate, just as not every message about Apple will be “embedded” in stock quotes. So why waste precious time and read all the reviews in a row?

The same applies to indices: first, determine which stocks of companies in which sector of the stock market are included in the indicator you selected. If the securities are selected by industry (for example, pharmaceutical, energy or industrial companies), then look in the analyst reviews for comments on the changing situation in that particular industry.

If you are trading in oil, you should not be scattered and read all the reviews in a row. Yours are the ones that talk about Brent, WTI, OPEC and energy resources.

You can find news that would really affect the change in the price chart on the FxTeam website and right inside your trading platform. Often, it contains a feed of messages from news agencies, and the Dividend Calendar can also be embedded. It specifies the dates when companies pay accrued earnings by the holder of their shares.

✔️ Central Bank rates When 
conducting fundamental analysis in forex, be sure to pay attention to the decisions on the monetary policy of the ECB and the Fed. In both cases, management meets every 6 weeks to agree on changes in interest rates, as well as to note changes in estimates of the economy. As a rule, the official wording is very much "smoothed" and "combed". It may seem to a beginner that the obvious things were said, but experienced observers act as "translators" into human language, comparing the previous passages in the comments with the current ones.

An important source of volatility for currencies is the comments of the heads of central banks during a press conference, which takes place shortly after the publication of the decision. On them, journalists ask questions in an attempt to get clarifications for the comments and to hear hints on future steps.

This is done, for example, by the European Central Bank; since 2019, the Fed also began to organize speeches, 30 minutes after the publication of the rate decision.

Markets react to changes in expectations, and therefore the most sensitive information is usually contained in the comments and explanations. Central banks call this policy "managing expectations." In recent years, they have tried to significantly improve this interaction with the market.

What's so important going on at these press conferences?

Journalists from all over the world ask the head of the Central Bank questions about the current economic situation in the region (for example, the Eurozone), further plans of the central bank and changes in monetary policy.
If you are fluent in English, we recommend, while conducting fundamental analysis, to watch live broadcasts of speeches, which are available on the official websites of central banks. At the same time, watch how this or that statement of the regulator's representatives affects the behavior of the rates of pairs with the national currency. It's best if you start seeing patterns yourself, in real time. This is a completely new, deeper understanding of the market.

During a press conference, the reaction of traders can be quite unexpected and strong. Let us recall that people trade in the market, and they are highly susceptible to emotions, fears and expectations. Very often, after re-evaluating all that has been said with a cold head, the markets experience corrections or pullbacks.

Few traders know that at each meeting the European Central Bank sets not one, but three interest rates. This process is versatile and affects different areas of the national economy.

It is also important to know that the ECB controls inflation based on the Harmonized Consumer Price Index, which is released monthly (preliminary estimate - on the last business day of the month, and final - in the middle of the next month). Significant deviations from forecasts are rare, but when they do, they lead to strong changes in the euro rate in pairs with all currencies of the Forex market.

It is also important to remember that the US Federal Reserve sets interest rates and monetary policy not only for its country, but also for the world reserve currency (and, therefore, the vast majority of the world). At the same time, not only the local economy is taken into account, but also the global one.

✔️  Economic Calendar
Forex analysis usually starts with checking the news of the Economic Calendar. This is the main tool of the analyst trader.

Open the Economic Calendar. You will see a table with data: at the time of publication of the current value, it immediately appears in the rightmost column. It also shows the time of publication, the name of the indicator, its description (appears if you click on the name), the previous and forecast value.

So how does the release of an economic indicator trigger a price movement?

To answer this question, let's take US Nonfarm Payrolls as an example. This is a monthly report that reflects changes in the number of jobs excluding agricultural workers over the last month. Relatively high values ​​are considered positive for the US dollar, causing a rise in the exchange rate (more jobs - more money from the population - higher purchasing power - stronger economy - attractive for investment). But the data below the forecast usually provoke a decline in the USD.

As a rule, macroeconomic indicators affect not one asset, but several at once.

Let's say that Nonfarm Payrolls, although it is directly related to the economy of the United States, also affects the movement of other currencies: the pound sterling or the euro, because they are pairs with the dollar (GBPUSD and EURUSD, respectively).

✔️  Financial and accounting reports of companies We
continue to study the fundamental analysis of securities. If a well-known company performed poorly for the quarter and made less profit than expected, this will upset investors, its shares will no longer be so attractive, they will start selling, and their price will fall. Therefore, report seasons, for example, are an important economic event in America. The company can report both before the American session and after it. Accordingly, if they report after, then already at the premarket of the next day it will be possible to see how the market reacts to the data received yesterday.

The publication of a report before the opening of the stock market may result in a gap (gap) in quotations already in the first minutes of trading. Or it may go unnoticed if the company has not demonstrated any "amazing" results (meaning, both in a positive and negative sense).

We also recommend that before you decide to trade on stocks, open the Dividend Calendar and check which company reports to shareholders today and pays interest.

Macroeconomic indicators

Here are examples of the most important economic indicators (such are the calendar icon in the form of painted three stars):
✔️  decision of the Central Bank's interest rate
✔️  Non-Farm Payrolls (the NFP)
✔️  Unemployment
Rate ✔️  Consumer Price Index
✔️  Gross Domestic Product (GDP)

News on the Economic Calendar on FxTeam may fall into one of the following categories: Growth, Inflation, Employment, Central Banks, Bonds, Real Estate, Consumers, Business, Speeches / Publications.

Also, all these events can be divided into three types:
✔️  Leading indicators
✔️ Lagging  indicators
✔️  Coinciding indicators

Leading indicators

Such indicators help to forecast future changes in the country's economy: changes in their values ​​warn that soon we will see a similar negative (or positive) effect in other sectors.

This category is the basis for a method of analysis that makes it possible, for example, to predict an impending recession. It is used by the heads of central banks, defining the vector of development in advance and adjusting the monetary policy. From here there are increases or decreases in rates. Private traders use the same data to quickly adjust their strategies.

Among the indicators of this type:
✔️  Obtaining building permits. The more permits issued, the more rosy the outlook awaits the construction and other related areas. The growth of the indicator indicates a future decline in the unemployment rate, as well as an increase in mortgage lending.
✔️  Consumer Confidence Index. In general, it shows whether the citizens of the country are ready to spend money or not; with its help determine the situation in the field of employment and the general state of the economy, up to the prospects for production.
✔️  Initial applications for unemployment benefits. More or less unemployed people have become over a certain period; as a result, it will be reflected in GDP, taxes paid, cost of purchases, etc.

Lagging indicators

Unlike leading indicators, they reflect changes in the economy that have already taken place over time. Traders use methods of working with these indicators to confirm the strength of market trends: since the economy has already begun to move in a certain direction, it means that you can open medium-term and long-term deals according to the general trend:
✔️  The unemployment rate. Indicates how many unemployed people are in the country at the moment.
✔️  Consumer Price Index. Shows how the price of a consumer basket changes over time.
✔️  Trade balance. The ratio of the value of goods exported and imported over a certain period of time.

Coinciding indicators

This type of indicators offers important information about the current economic state of a country. Coincident indicators can give traders a detailed breakdown of current market trends, allowing them to tailor a strategy to an evolving trend. Among such data:
✔️  Personal income. The amount of income of an individual from all sources.
✔️  Retail sales. Reflects the change in retail sales.
✔️  Gross Domestic Product, GDP. The cost of all goods and services produced in the country for a year or quarter.

Force Majeure
✔️  Military conflicts
Countries involved in a military conflict must finance weapons, cope with losses and even prevent them, as well as manage the consciousness of the masses, in which fear and chaos reign. All this will undoubtedly destabilize the economy.

Consequently, a protracted confrontation can lead to significant market volatility and cause a depreciation of the national currencies of the warring countries.

✔️  Disasters and Natural Disasters
Natural disasters include extreme weather events such as floods, earthquakes, hurricanes and tsunamis. Mass casualties, damage to infrastructure and a general sense of fear can have a detrimental effect on a country's economy, especially given the government's hefty budget for reconstruction.

В результате, национальная валюта неизбежно ослабевает. Так, к примеру, новозеландский доллар потерял 5% в течение двух недель после землетрясения 16 августа 2013 года, снижаясь по мере поступления информации о масштабах разрушения. Японская иена, наоборот, после катастрофического землетрясения и цунами 2011 года, которые привели к гибели 15000 человек, тысячам раненых и пропавших без вести 11 марта 2011 года иена взлетела на 7% к доллару США, пока Банк Японии не вышел на рынок с интервенциями, чтобы остановить это движение.

✔️  Political instability
Other significant phenomena include announcements of a recession, comments from politicians after meetings, unexpected management decisions, scandals, sanctions, confrontations, results of negotiations between leaders of countries, discussions in economic forums and sudden state participation in the form of shares in private companies: a possible method of saving the economy, which must be taken into account when conducting a fundamental analysis of stocks in crisis and post-crisis times. The elections and the risk of a change in the course of the government are also perceived as political instability, capable of destabilizing both the exchange rate and the country's stock markets until the prospects are clear.

Fundamental analysis of the Forex market

✔️  Political factors
The most striking event in this category is, of course, the election of the president or the ruling party. These factors, as a rule, cause increased fluctuations in the exchange rate of the national currency (increase volatility). If the likelihood that the upcoming elections could lead to a change of government is high enough, then political instability will lead to a depreciation.

✔️  Economic factors
It does not matter whether you trade currencies, stocks, indices or any other financial instruments, it is important to first get a complete picture of the situation in the country to which the selected asset belongs. In particular, you need to understand what forces are affecting the national economy and what type of news you need to follow in the first place.

Open the Economic Calendar on the FxTeam website and find news with two or three stars. These are the publications of statistical data that have the strongest impact on the currencies of the countries for which they are published. Before you start trading, you need to make sure that no events will be published while your trade is in the market.

If you are an adherent of the strategy of trading on the news, on the contrary, you will absolutely need to know the time of data release in order to open the relevant transactions.

Pros and cons of fundamental analysis

Advantages:
✔️ The  ability to see the entire economic picture as a whole (no other type of analysis gives this)
✔️ The  ability to understand and predict market movements (technical analysis only shows, and fundamental analysis explains )
✔️  Ability to assess the prospects of an economy or a particular industry / asset class.

Disadvantages:
✔️  Too many influencing variables.
✔️ The  need to constantly follow the news, keep abreast of everything and not miss events in the Economic Calendar (without this, analysis is impossible).
✔️  Fundamental analysis must be combined with other types in order to focus specifically on the chart at the moment. Technical, wave
analysis and Price Action (patterns) come to the rescue .