In this post we are going to talk about Fundamental Analysis and how you may use it to better understand the market.
Fundamental Analysis (FA) is one of the most important tools an investor has at his disposal. I personally use it very often, and it is one of the five pillars of my trading methodology, which is composed by: Technical Analysis; Fundamental Analysis; Risk Management; Behavioral Finance; and Game Theory.
The most important thing to keep in mind is that, as Technical Analysis, the Fundamental Analysis will give you answers to help you in your decision-making process.
Technical analysis will tell you when you should invest or trade, while the fundamental analysis will tell you why (or why not).
Also, to complement this series of articles about FA, I recommend the Benjamin Graham’s book: The Intelligent Investor, which you can find right here!
This is not an ordinary book, as Warren Buffett himself claims, this is the best book about investments he ever read – so, yes, you must read it if you want to be a great investor! Knowledge is power!
Mr. Buffett learned the famous Buy and Hold method with Graham, which is a method of buying cheap stocks, and wait for them to increase in value through time – never selling it.
But the trick is to know when a stock is cheap or not, and the fundamental analysis will help us from now on.
Of course, I’m talking about stocks, but you can use FA on any asset, like on futures, cryptocurrencies and bonds.
Questions you should make
When you are analyzing a stock, there are some questions you should look to answer during your analysis, like:
- Is the revenue growing?
- Does the company record profits?
- How about the corporate governance?
- What are the company’s plans?
I hope you are starting to see a pattern here!
There are questions that are all about numbers and data, and others that are more abstract and impossible to quantify. Therefore, the fundamental analysis can be divided into two different parts:
Quantitative and Qualitative
The quantitative part will tell you the numbers of a company: Its margins, profits, ratios, balance sheets, etc. While the quantitative part will tell you about the company’s management, its plans, shareholders, position in the market, SWOT analysis, etc.
And there are different approaches to do a fundamental analysis as well:
Top/Down vs Bottom/Up
A top/down approach will analyze the macroeconomic scenario first, analyzing economic indicators like the interest rates, inflation and unemployment. Second, you’ll analyze the market, screening its sectors. Then, you will analyze the companies.
The bottom/up approach is just the inverse logic of a top/down analysis. You’ll start from the company to the macroeconomic scenario.
As is with technical analysis, the fundamental analysis is not predictive – it just tells if you are doing the right thing at this moment. It is a powerful tool that can make you a wise investor.
If you want to learn more deeply about fundamental analysis and how I use it in my trading methodology, check it here to become a member.
See you soon.