The Basics of Fundamental Analysis

Fundamental analysis has a broad definition that encompasses a wide range of market-related applications. At its core, fundamental analysis takes into account economic data, news items, projections, and statistical reports in an attempt to identify opportunity within the marketplace.

What Is Intrinsic Value?

The primary objective of fundamental analysis is the identification of a security’s intrinsic value. Intrinsic value is defined as being the “true” or “real” value of an asset or asset class, not the prevailing market value. While it is frequently debated whether or not intrinsic value actually exists, many traders and investors are proactive in seeking profit from finding “undervalued” or “overvalued” securities.

Perhaps the most traditional way of capitalizing upon the concept of intrinsic value is through enacting a “buy and hold” strategy on a company’s stock. Many titans of the financial industry champion “buy and hold,” and there are certainly many upsides to its application.

However, the futures markets of the world offer several unique advantages to individuals interested in profiting from the notion of intrinsic value:

• flexibility: A trader may buy or sell a futures contract in an attempt to profit from either a rising market or a falling market.
  
  
• leverage: The availability of increased degrees of leverage enable traders to profit from short-term market volatilities without tremendous initial capital outlays.
  
  
• variety: Contracts based upon agricultural commodities, energy products, debt instruments, and equities indices offer futures traders a vast array of options.

Traders can identify intrinsic value in nearly any asset class, product, or market. Identification of the “real” or “true” value of an asset is a complex, subjective exercise. Industry professionals are often a great resource, bringing experience and a vast knowledge base to the process.

Qualitative and Quantitative Analytics

Fundamental analysis has two primary disciplines: quantitative and qualitative analytics. Both areas represent specific types of data, as well as the methods by which traders use each to identify intrinsic value.

Quantitative analytics are data sets and processes that are directly measurable and capable of being expressed by numbers. In contrast to technical analysis, quantitative analytics focuses on hard market data instead of purely price action. In futures, key quantitative inputs that act as basic market fundamentals are:

• official macroeconomic data reports
• industry-specific supply-and-demand projections
• national and regional import/export statistics
• growth and inflation projections

Qualitative analytics are a bit more complex than quantitative because there’s a large degree of subjectivity involved in the process. Qualitative analytics are not rooted in mathematics; they are a product of intangible data that is often acquired through experience or intuition. In the trade of futures, qualitative analytics can play a crucial part of interpreting a market while formulating a plan to capitalize upon opportunity. A few examples of quantitative analytics are:

• working knowledge of geopolitics
• trend recognition in producer/consumer behavior
• identification of interrelationships across markets
• cyclical pattern recognition

In each market, specific fundamentals are more relevant to spotting a potential opportunity than others. Being able to combine statistical data with market experience in order to recognize a viable trading opportunity is what fundamental analysis is all about.

Putting It All Together

Depending upon the type of security, trading approach, and the individual market being traded, traders can integrate many unique factors into their fundamental analysis methodology. However, no matter what type of security a trader is actively trading, the concept of intrinsic value — as well as the integration of quantitative and qualitative analytics — serve as the building blocks of fundamental analysis.

Often, the success of any market-based analytical approach is greatly dependent upon having an adequate knowledge of the basics and the experience to interpret them correctly. This can most certainly be a daunting task. Enrolling the services of a futures market professional may provide access to an abundance of relevant experience and knowledge.