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.
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.
