Fundamental Analysis Basics for Trading

Fundamental analysis relies on the principle that assets are often priced incorrectly and that the market is constantly trying to correct these prices. Outside events that affect asset prices are generally responsible for price corrections so traders are required to keep informed about assets via the print media, company announcements and news items.

Fundamental analysis is highly subjective as the investor is forming a view based largely upon outside events. To successfully utilise fundamental analysis, traders would need to study all levels of data from the company level, industry level and market level, right through to country-wide and global levels.  Many events are interrelated and can affect the price of different assets and even different asset classes.

Although both technical and fundamental analyses will, on their own, assist traders in making successful forecasts, a combination of these analyses offers the best chance for success in trading.

Company Information

It is essential to have complete information about a company when using the company’s share price as the basis for a binary options trade. A trader should keep informed about the company through news items and press releases and consider analysts’ opinions. A company’s published accounts should be used to assess the company’s performance and to calculate figures and ratios, including:

• earnings per share (EPS) that provides a measure of the value of each share,
• price to earnings (P/E) to determine if a share is under- or over-valued,
• projected earnings growth (PEG) to compare the share price to annual growth,
• book value as total assets less total liabilities,
• price to book (P/B) compares the share price to the company’s asset value,
• price to sales (P/S) to show the share price in relation to annual sales,
• dividend yield as a percentage of the company’s share price,
• return on equity (ROE) to determine the effectiveness of using the money invested.

It should be noted that any information or news about a company may have far reaching effects.  For example, a new product announcement might raise a company’s share price and, at the same time, lower competitor share prices.

Industry News

The performance of an industry is likely to affect the value of all of the companies that comprise it.  In other words, a successful company may find its share prices dragged down by an industry that is in general decline, or alternatively, a struggling company may experience a rise in share prices as the wider industry grows or improves.  A company will always be associated with its particular industry. Although it may perform better or worse than its overall industry, its share prices will still reflect the performance of the industry in the market.

Traders should look out for industries that are on the upswing and aim to trade with companies that are part of these industries.

Natural Events

Natural disasters and weather events can also influence the price of commodities as assets are obviously affected by supply and demand. For example, a severe storm or act of nature that has resulted in wide-scale destruction of farm crops will force a price rise in that particular industry.   A hurricane that shuts down an oil field is also likely to cause a price rise as supply of oil will be affected.

The effects of natural events may be fairly easy to predict but they can be far reaching. If there is a commodity price rise due to affected supply, the company’s share price may increase. On the other hand, a company that uses a lot of the commodity may suffer a drop in share price. In addition, a country that is a major producer may benefit greatly through exports and may also experience a rise in currency.

Fear Factor

Markets can often rise and fall quickly and with little logic, as changes can often be driven by fear. It is difficult to predict how a market will react to fear as a factor for change, but often the market will establish an upward or downward trend and move in this direction for a period of time. Successful binary options traders will keep informed through media to help identify trends that may result in panic or calm in the markets.

Market Conditions

Bull markets result from price rises and bear markets from falling prices. These markets can become established for lengthy periods, often years, and will help identify the direction of price movements.

This can be useful in not only trading an index but also individual company shares. A company’s level of success in the market will be affected by prevailing market condition.

Markets can also become bound within a range, with prices moving within a narrow band, regardless of the direction alluded to by the long term trend. Market volatility is also possible, resulting in wide price variations. By studying events that may influence the market, traders can gain knowledge about overall movements.

Economic Performance

Large national budget deficits are manageable for the short term.  However, longer term budget deficits can cause problems often resulting in a devalued currency that allows the country to limit imports and attempt to increase exports –measures aimed at hopefully lowering or eradicating the country’s deficit. A free floating currency can devalue easily against other stronger economies.  The Euro presents a bigger challenge with so many countries with varying performance levels under one currency.

Interest rates are often used as an economic weapon with rising interest rates making a currency more attractive and increasing its value against other currencies. However, other countries can also shift their interest rates up or down and it is the difference between rates that sets the currency pair value. Prices usually move in anticipation of an interest rate change.

Falling currencies and budget deficits therefore, can affect import commodity prices which can also impact on other parts of the economy, especially share prices for companies that are widely involved in importing and exporting.

Economic Indicators

Leading economic indicators are significant in forecasting price movements because they change before the economy does. Stock market returns are an example of this as the markets tend to rise before the end of a recession.

Lagged economic indicators occur after the economy changes direction.  For example, the unemployment rate will usually improve two to three quarters after the economy re-enters a period of growth.

Coincident economic indicators, such as GDP, generally move in line with the overall economy.

A variety of different economic indicators are published that analyse the current economic performance or predict future performance and these can often have different timelines in relation to the way in which an economy may change.

Fundamental Analysis Basics for Binary Options Trading

Comments are closed.