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Introduction
to Fundamental Analysis courtesy
Fundamental analysis refers to the study of the core
underlying elements that influence the economy of a particular entity.
It is a method of study that attempts to predict price action and market
trends by analyzing economic indicators, government policy and societal
factors (to name just a few elements) within a business cycle framework.
If you think of the financial markets as a big clock, the fundamentals
are the gears and springs that move the hands around the face. Anyone
walking down the street can look at this clock and tell you what time
it is now, but the fundamentalist can tell you how it came to be this
time and more importantly, what time (or more precisely, what price)
it will be in the future.
There is a tendency to pigeonhole traders into two distinct schools
of market analysis - fundamental and technical. Indeed, the first question
posed to you after you tell someone that you are a trader is generally
"Are you a technician or a fundamentalist?" The reality is that it has
become increasingly difficult to be a purist of either persuasion. Fundamentalists
need to keep an eye on the various signals derived from the price action
on charts, while few technicians can afford to completely ignore impending
economic data, critical political decisions or the myriad of societal
issues that influence prices.
Bearing in mind that the financial underpinnings
of any country, trading bloc or multinational industry takes into account
many factors, including social, political and economic influences, staying
on top of an extremely fluid fundamental picture can be challenging.
At the same time, you'll find that your knowledge and understanding
of a dynamic global market will increase immeasurably as you delve further
and further into the complexities and subtleties of the fundamentals
of the markets.
Fundamental analysis
is a very effective way to forecast economic conditions, but not necessarily
exact market prices. For example, when analyzing an economist's
forecast of the upcoming GDP or employment report, you begin to get
a fairly clear picture of the general health of the economy and the
forces at work behind it. However, you'll need to come up with a precise
method as to how best to translate this information into entry and exit
points for a particular trading strategy.
A trader who studies
the markets using fundamental analysis will generally create models
to formulate a trading strategy. These models typically utilize
a host of empirical data and attempt to forecast market behavior and
estimate future values or prices by using past values of core economic
indicators. This information is then used to derive specific trades
that best exploit this information.
Forecasting models
are as numerous and varied as the traders and market buffs that create
them. Two people can look at the exact same data and come up
with two completely different conclusions about how the market will
be influenced by it. Therefore is it important that before casting yourself
into a particular mold regarding any aspect of market analysis, you
study the fundamentals and see how they best fit your trading style
and expectations.
Don't succumb to 'paralysis
by analysis.' Given the multitude of factors that fall under
the heading of "The Fundamentals," there is a distinct danger of information
overload. Sometimes traders fall into this trap and are unable to pull
the trigger on a trade. This is one of the reasons why many traders
turn to technical analysis. To some, technical analysis is seen as a
way to transform all of the fundamental factors that influence the markets
into one simple tool, prices. However, trading a particular market without
knowing a great deal about the exact nature of its underlying elements
is like fishing without bait. You might get lucky and snare a few on
occasion but it's not the best approach over the long haul.
For forex traders, the fundamentals are everything
that makes a country tick. From interest rates and central bank policy
to natural disasters, the fundamentals are a dynamic mix of distinct
plans, erratic behaviors and unforeseen events. Therefore, it is best
to get a handle on the most influential contributors to this diverse
mix than it is to formulate a comprehensive list of all "The Fundamentals."
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