Fundamental Analysis

We understand how powerful knowledge can be when it comes to trading in the vast financial markets of today. It is the one thing that all successful traders have in common. You can think of it as the foundation upon which you build your fortress. It is with this solid foundation that you will be able to build the knowledge structures and trading habits that will contribute to your success as a trader. No matter your choice of financial market, trading vehicle or asset, having a good grasp over the core tenants of the markets will only benefit you. In this section, we will explore a method of market analysis you will be able to use throughout your journey in the financial markets: news trading.

News trading, commonly referred to as fundamental analysis, takes into account factors such as geopolitical news events, the reading of market sentiment and economic indicators when it comes to helping traders make informed decisions in the financial markets. The root of this principle is the fact that, at any point in time, assets are either overvalued or undervalued, and are continuously in the process of correcting themselves and moving towards their true value. News trading is employed to establish what this true value is, thus allowing traders to capitalize on an asset’s rise or fall towards it. It is because of this reason that news trading is so focused on external events. The core belief is that events affect sentiment, and sentiment is what drives markets.

Market research is central to news trading as all information that may potentially reveal more about an asset’s true value (in other words, the direction in which the market is likely to head) is immensely helpful. This is why news trading is so concerned with looking at the external factors which affect the market price of assets. These external factors come in the form of geopolitical news (natural disasters, global conflicts), market news (bankruptcies, mergers), economic indicators (Gross Domestic Product figures, employment reports, interest rate decisions) and the reading of market sentiment. Let us now take a look at a number of these external factors and explore the role they play within the financial markets.

Geopolitical events consist of both geographic and political factors. Geographical factors are factors concerning the natural features of the world and the global population. Political factors are factors related to policy or systems of government, often taking into account political parties and the relationships between states or countries. Both geographical and political factors play a role in influencing or delineating a country or region, which allows them to be used in the analysis of economic performance. In turn, this allows us to predict the future performance of tradable assets within the respective countries or regions. The following are examples of geopolitical events which can be used in fundamental analysis:

Disasters

Disasters, both of the natural and manmade sort, have a profound impact on the financial markets. They interrupt the lives of people living in the affected regions and introduce disruptions to their daily lives. Additionally, disasters have the tendency to damage (or, in the worst case, completely destroy) infrastructures which are essentially the backbones of economies.

One example of such a disaster was the explosion of an oil rig that British Petroleum (BP) was renting in the Gulf of Mexico in 2010. Every day from the point of the explosion, thousands of barrels of oil were leaked into the ocean. Not surprisingly, BP stocks plummeted, leading to the company losing approximately $25 billion worth of market share. This falling of BP stocks is not the only negative impact of the oil spill.

Property values in the region also took a huge plunge. The falling property values affected not only the coastal regions close to the oil spill, but also those farther inland. Fisheries along the 635 miles of coast tainted by the oil spill suffered the most, leading to a considerable knock-on effect on housing and employment in the region. As a direct result of the BP oil spill of 2010, an estimated 22,000 jobs were lost.

The impact of this disaster had more than short-term effects. The oil spill would carry on to have a social stigma attached to the purchasing of property within the nearby vicinities, which played a part in the falling property prices of up to 15%. The estimated total cost of the BP oil spill for the economy of the region was approximately $8.4 billion with subsequent negative implications for both the GDP of the US and the value of the US Dollar.

War

What probably impacts the value of assets more than anything else is the presence of war. The conflict does not even have to be taking place at the current moment–even the suggestion of war in the Middle East is enough to trigger an exponential rise in the price of crude oil because of the fact that the region is such a large player in the oil industry, it being a major exporter.

Why do the prices of crude oil increase sharply during these times of war? The answer is simply supply and demand. The oil fields in areas of conflict show a decrease in production, or a complete cessation of any production at all. This leads to a decrease in the supply of crude oil in the market, which, as a consequence, leads to a rapid rise in its price.

In addition to the prices of crude oil rising in the Middle East during times of war, the stocks of military equipment companies and weapons manufacturers can be expected to increase as the region prepares for armed conflict. Like the movement of crude oil prices, the stocks of military equipment companies and weapons manufacturers are influenced by changes in supply and demand. This creates a domino-effect where the raw materials that are needed to product the military equipment also see a rise in demand, and thus value. As a consequence, the stock prices of the mining companies responsible for extracting the raw materials used for the production of weapons can also be expected to rise.

We know now how much of a role geopolitical events play in the influencing of the financial markets. Next, we are going to explore economic indicators, another prime factor which we can study in order to better understand how price trends move. An economic indicator is a statistic about the economy through which traders can analyze economic performance and make predictions of future performance. As its name suggests, what an economic indicator basically does is indicate how well the economy is doing at the present moment, and offer a read as to how well it will do in the future. Economic indicators can be categorized broadly as the following:

Leading Indicators

A leading indicator typically moves prior to a country’s economy, and can thus be used as means through which traders are able to take short term positions regarding the relative health of the country’s economy. What are a particularly useful leading indicators are stock market return figures, as they generally tend to rise or fall before the respective country’s economy demonstrates the fluctuation. Other leading indicators which will be helpful for traders to observe are the number of building permit applications currently in the works, the money supply of a given country or region (in other words, the aggregated monetary assets at a specific period in time) and the results of consumer expectation surveys.

Lagging Indicators

As its name suggests, lagging indicators typically report changes that have already been registered by the economy. An example would be in the form of reports which denote the accumulated data of events that have passed. A curious incongruity in fundamental analysis is that many of the indicators traders pay attention to and rely heavily on are in fact lagging indicators. While it may seem rather peculiar and even unhelpful to think that lagging indicators could ever demonstrate such a quantitative effect on the financial markets, they nonetheless do. This is because a great majority of trading activity that occurs on a daily basis is rooted in trader psychology. The fortunes of a currency are influenced by market sentiment as much as (and some would say even more than) the numbers on a balance sheet. Thus, lagging indicators like trade balance statistics and interest rate figures are important to pay attention to when making your trade decisions.

Coincident Indicators

The final type of economic indicator, the coincident indicator, moves the same way an economy does. In doing so, it tells us all we need to know about a given economic state of play. Some examples of coincident economic indicators are: average weekly hours worked, real earnings, and employment numbers. These coincident indicators are important for traders to pay attention to should they wish to monitor the health of a given economy and understand how its currency is being valued.

Once we have a better understanding of what economic indicators are and the categories in which they can be represented, we can take a look at some important economic indicators that have a major role to play in news trading. The following economic indicators are prime movers in the financial markets, and as a Fort trader, having an in-depth understanding of them will allow you to make wiser decisions and thus be able to make the right predictions when it comes to trading.

Gross Domestic Product (GDP)

The term Gross Domestic Product (GDP) denotes the aggregated value of all goods and services produced by a given country or economic region. GDP tells traders whether an economy is growing or shrinking. A GDP which is larger than that of the previous release indicates an expanding economy, and, conversely, a GDP which is lower than previously reported indicates a contracting economy. As a consequence, a GDP figure which is higher than forecasted means positive things for the respective country’s currency.

GDP is considered a lagging indicator because it is released every quarter. When it comes to Europe, for example, the impact of this particular release is buffered because both France and Germany release the GDP figures of their respective countries ahead of the European report. As the economies of France and Germany make up approximately half of the region’s GDP, traders find it helpful for them to monitor the GDPs of these two nations and trade on the individual GDP releases rather than on the sentiment generated by this specific indicator. This is something for all Fort traders to take note of when to comes to indicators which have a national, then regional report.

Another thing which is important to note is the fact that GDP is released in waves. What is released first is called the first estimate (also referred to as the flash GDP). After which, the revised GDP figures may be released (as in the case with European Union). The last of the figures to be released will be the final GDP. In most cases, the initial release has a much larger influence on the financial markets than the final GDP.

Trade Balance

Trade balance reports are key to a nation’s or economic bloc’s balance of payments and are thus significant. Usually expressed by the yearly percentage of change in terms of millions of the unit of the respective currency, trade balance statistics are attained through the weighing of a country’s imports against its exports over a specified period of time.

As they provide invaluable insight into the strength of a currency, they are extremely useful to forex traders. A currency’s value is negatively affected by trade deficits. If a deficit over a particular period of time is reported in a country’s trade balance statistics (that is to say, if the figure is negative), it will mean more capital is leaving than entering. This is because more goods have imported than exported. On the flipside, if the trade balance report denotes a trade surplus, it means more goods have been exported than imported. The effect of a trade surplus is typically beneficial to a currency’s value, except in the case where large outflows of cash negate the benefits conferred by the trade surplus.

Retail Sales

It is advantageous for traders to pay attention to retail sales reports and consider them important economic data releases as they provide a comprehensive gauge of a country or region’s overall economic status. This is because consumer spending is responsible for a sizeable portion of a country’s economic activity. Positive retail sales reports are related to many other areas of a country’s economy. They provide for all traders a good look into the consumer confidence and are firmly tied with employment health in the retail sector. Should retail sales figures prove more positive than originally expected, they will without a doubt have a part to play in the strengthening of a given country’s currency.

Monthly retail sales reports are typically released into the following month. They reflect consumer spending habits across their respective countries or regions. To go back to the example of Europe, the influence of the region’s retail sales report is diminished by France and Germany releasing their own figures prior. Traders of the Euro who are looking to capitalize on retail sales reports in Europe will usually weight Germany more heavily into their consideration. This is wise because Germany is the most powerful of the Euro-zone economies. Therefore, its retail sales report will be a very helpful overall indicator of the economic health of the entire region.