There are various tools and techniques that can be used for fundamental analysis, but they have been categorised into two types of fundamental analysis: top-down analysis and bottom-up analysis. Top-down analysis takes a broader view of the economy, starting with the entire market before narrowing down into a sector, industry and finally a specific company. Conversely, bottom-up analysis starts with a specific stock and widens out to consider all the factors that impact its price. Most fundamental analysis is used for evaluating share prices, but it can be used across a range of asset classes, such as bonds and forex. The tools that traders might choose for their fundamental analysis vary depending on which asset is being traded. For example, share traders might choose to look at the figures in a company’s earnings report: revenue, earning per share (EPS), projected growth or profit margins. While forex traders may choose to assess the figures released by central banks that allow insight into the state of a country’s economy.
Pros and Cons of Fundamental Analysis
Fundamental analysis helps traders and investors to gather the right information to make rational decisions about what position to take. By basing these decisions on financial data, there is limited room for personal biases. Rather than establishing entry and exit points, fundamental analysis seeks to understand the value of an asset, so that traders can take a much longer-term view of the market. Once the trader has determined a numerical value for the asset, they can compare it to the current market price to assess whether the asset is over- or under-valued. The aim is to then profit from the market correction. As fundamental analysis takes a much longer-term view of the market, the results of the findings are not suitable for quick decisions. Traders looking to create a methodology for entering and exiting trades in the short-term might be better suited to technical analysis. It is also important to consider the best and the worst-case scenario. While fundamental analysis provides a more well-rounded view of the market, it is possible for negative economic, political or legislative changes to surprise markets.