Fundamentalanalyse serie

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Fundamental Analysis on the Series 7 Exam

1,001 Series 7 Exam Practice Questions For Dummies

Fundamental analysts examine the specifics of corporations and are responsible for doing the research and recommending which securities the registered reps should promote. As a registered rep, you’ll also be responsible for examining your customers’ portfolios to help them keep in line with their investment objectives.

Practice questions

Which of the following is NOT considered a quick asset?

B. accounts receivable

C. marketable securities

Answer: A. inventory

Current assets (assets convertible into cash within a one-year period) include inventory, marketable securities held by the corporation, cash, and so on. However, when dealing with quick assets, you have to take inventory out of the equation. Quick assets are convertible into cash within a three- to five-month period. In most cases, inventory takes longer to sell than three to five months.

Cash flow equals

A. net income – depreciation

B. gross income + depreciation + depletion

C. net income + depreciation + depletion

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D. gross income – depletion + depreciation

Answer: C. net income + depreciation + depletion

Cash flow helps measure the financial health of a company. Cash flow is determined by taking the net income (after-tax income) and adding back in the depreciation and depletion deductions (if any). You need to add depreciation and depletion back in because they’re write-offs for a company but aren’t out-of-pocket expenses. So the equation looks like this:

Cash flow = net income + depreciation + depletion

PE ratio equals

A. the market price divided by the earnings per share

B. annual dividends per common share divided by the market price

C. annual dividends per common share divided by earnings per share

D. net income minus preferred dividends divided by the number of common shares outstanding

Answer: A. the market price divided by the earnings per share

The PE ratio is a tool that technical analysts use to help determine whether a stock is overpriced or underpriced. Typically, they’ll compare the PE ratios of several different companies within the same industry to see whether there’s a good investment opportunity. Actually, the lower the PE ratio, the better. A company with a low PE ratio means that the earnings per share (EPS) are high compared to its price. The equation for PE ratio is

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Reading time: 9 minutes

Fundamental analysis is a method of analysing financial markets with the purpose of price forecasting. Forex fundamental analysis focuses on the overall state of the economy, and researches various factors including interest rates, employment, GDP, international trade and manufacturing, as well as their relative impact on the value of the national currency they relate to.

The core premise of fundamental analysis in Forex, as well as other financial markets, is that the price of an asset may differ from its value. For this reason, various markets may sometimes misprice an asset, overprice, or underprice it in the short run. Fundamentalists claim that despite being mispriced in the short-term, the assets will always return to the correct price eventually. The end goal of performing fundamental analysis is to discover the true value of an asset, to compare it to the current price, and to locate a trading opportunity.

This also nicely demonstrates the key difference between fundamental and technical analysis. While technical analysis barely pays attention to anything but the current price, fundamental analysis researches everything but the current price. Whilst it is true that fundamental analysis may not be the best tool for a short-term trader in day-to-day markets, it is the fundamental Forex factors and how they are analysed that answer what happens in the long-term.

Methodology

FX fundamental analysis isn’t just about comparing the current data of single economic indicators to previous data. There are a great number of economic theories which surround fundamental Forex analysis, attempting to put various pieces of economic data in context, to make it comparable.

The most popular economic theories of currency fundamental analysis babysit the notion of parity – a condition of price at which currencies should be exchanged when adjusted, according to their local economic factors, such as inflation and interest rates.

Understanding Fundamental Analysis

The following video explains how fundamental analysis is used to monitor major news releases, and what traders can expect to happen in the financial markets when certain data has been released:

Good News – Bad News

You may have noticed that from the very practical standpoint of an average Forex trader, it is news reports that produce movements on the markets. How and why does this happen? There are several economic indicators that financial experts observe because they can provide hints on the health of the economy.

These indicators are found in news reports and news outlets. Some are released weekly, most are released monthly, and a few quarterly. You can track such announcements and developments through our Forex calendar. Now let’s compare technical and fundamental analysis by the frequency of data updates.

In the case of currency trading fundamental analysis, new data arrives every second in the form of a price quote, while fundamental indicators are only published once a week at the most. Capital flows gradually from countries where it accumulates at a potentially slower rate, compared to the countries where it could accumulate at a potentially faster rate.

That has everything to do with the strength of an economy. If an economy is forecast to hold strong, it will appear as an attractive place for foreign investment, because it is more likely to produce higher returns in the financial markets.

Following that thought, in order to invest, investors will first have to convert their capital into the currency of the country in question. Buying more of that currency will push the demand, and force the currency to appreciate. Unfortunately, economics is not that simple, which is why examples of healthy economies showing weakening currencies are not exactly unknown to history. Currencies are not like company stock, that directly reflects the health of the economy.

Currencies are also tools that can be manipulated by the policy makers – such as central banks and even private traders like George Soros.

When economic reports are released, traders and investors will look for signs of strengths or weaknesses in different economies. If prior to the news releases, the market sentiment leans in one direction, changing the price before the release is known as a ‚priced in market‘. It often causes a little commotion upon the actual data release.

Conversely, when the market is unsure – or the data results vary from what was anticipated – severe market volatility may occur. That is why Forex rookie traders are generally advised to stay away from trading around the news when practising fundamental analysis.

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Major Economic Indicators

Economic data may hint towards shifts in the economic situation of a respective country.

Interest rates

Interest rates are a major fundamental Forex analysis indicator. There are many kinds of interest rates, but here we will focus on the nominal or base interest rates set by central banks. Central banks create money, that money is then borrowed by private banks. The percentage or the principle that private banks pay central banks for borrowing currencies is called a base or a nominal interest rate. Whenever you hear the phrase ‚interest rates‘, people are usually referring to that concept.

  • Manipulating interest rates – a big part of the national monetary or fiscal policy – is one of the primary functions of central banks. This is because interest rates are a great leveller of the economy. Interest rates are perhaps stronger than any other factor, and they influence currency values. They can have an impact on inflation, investment, trade, production and unemployment.

Here is how it works:

The central banks generally wish to boost the economy and reach a government-set inflation level, so they decrease interest rates accordingly. This stimulates borrowing by both private banks and individuals, as well as stimulating consumption, production and the economy in general. Low interest rates can be a good tactic, but a poor strategy.

In the long-term, low interest rates can over-inflate the economy with cash, and can create economic bubbles, which as we know, sooner or later will set a toppling chain reaction across the economy, if not entire economies.

To avoid this, central banks can also increase interest rates, thus cutting borrowing rates and leaving less money for banks, businesses and individuals to play around with. From a Forex fundamental analysis standpoint, the best place to start looking for trading opportunities is in the changing interest rates.

Inflation

News releases on inflation report on the fluctuations in the cost of goods over a period of time. Note that every economy has a level of what it considers ‚healthy inflation‘. Over a long period of time, as the economy grows, so should the amount of money in circulation, which is the definition of inflation. The trick is for governments and central banks to balance themselves at that self-set level.

Too much inflation tips the balance of supply and demand in favour of supply, and the currency depreciates because there is simply more of it than demanded. The converse side of the inflation coin is deflation. During deflation, the value of money increases, whilst goods and services become cheaper.

In the short run it may be a positive thing, but for the economy in the long run, it can be a negative thing. Money is fuel for the economy. Less fuel equals less movement. At some point deflation may have a drastic impact on a country, to the extent that there will hardly be enough money to keep the economy going, let alone to drive the economy forward.

GDP

Gross domestic product (GDP) is the measurement of all goods and services a country generates within a given period. GDP is believed to be the best overall economic indicator of the health of an economy. This can seem odd, especially considering GDP is basically a measurement of the supply of goods and services, yet it has nothing to do with the demand for these goods and services.

The general idea is that it takes a great deal of knowledge of both supply and demand to make reasonable, accurate estimations. It would be unwise to believe that GDP reflects both sides of the market. Therefore, an increase in GDP without a corresponding increase in gross domestic product demand or affordability, is the very opposite of a healthy economy, from a fundamental Forex analysis perspective.

Interest rates, inflation, and GDP are the three main economic indicators employed by Forex fundamental analysis. They are unmatched by the amount of the economic impact that they can generate, compared to other factors such as retail sales, capital flow, traded balance, as well as bond prices and numerous additional macroeconomic and geopolitical factors. Moreover, economic indicators are not only measured against each other through time, but some of them also correlate cross-discipline and cross-borders.

You can learn more about this with our article on ‚ The Best Forex Fundamental Indicators Explained, Part 1‘

It is important to understand that there is a lot of economic data released that has a significant impact on the Forex market. Whether you want to or not, you need to learn how to make Forex fundamental analysis a part of your trading strategy to predict market movements.

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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.

The fundamental analysis

Concept and basics of „fundamental analysis“. Factors that influence fundamental analysis.

Introduction

Technical analysis

Fundamental analysis

Trading Psychology

Risk and money management

Creating trading strategy

Fundamental analysis means measurement of a financial asset value in connection with political and economic processes and events.

There is a connection between financial-economic, political, and economic events that take place in individual countries and blocks of countries as well as in the whole world and currency exchange rates and stock prices.This connection can be studied using the fundamental analysis.

Fundamental analysis is the most difficult part of economic analysis of the market. It is more difficult than any other one, because under different conditions the same factors can have different impact on the market and major factors can become quite insignificant. In addition to certain initial official rules, such analysis requires practical experience.

In practice, methods of fundamental analysis are used by market traders in combination with other types of market analysis and allow evaluation of general history and perspectives of trading instrument rates based on interdependence between fundamental, economic and other factors and standard response of trading markets to them.

Fundamental analysis takes into consideration the following factors:

  • Political crises;
  • Much publicized resignations and Cabinet of Ministers reshuffles;
  • Imprudent statements in press;
  • Release of economic indicators for countries and blocks of countries;
  • International conflicts;
  • Awaited elections;
  • Natural disasters (force-majeure).

All events considered in the fundamental analysis can be planned or unplanned. All planned events (release of economic indicators, planned speeches given by the Heads of the Cabinets or other influential officials, release of the election results etc.) are published in the economic calendar. Unplanned events include any force-majeure (fire, natural disasters, acts of terrorism etc.). Furthermore, in the course of fundamental analysis politics means redistribution of public good and resources based on economics-related reasons.

Market response to any unplanned event as assessed in the context of fundamental analysis is unpredictable and depends on a specific situation. The history has seen political events that changed dollar exchange rate against other currencies by 200 points within a very short period of time. (For example Caribbean Sea oil spill, the capture of Saddam Hussein by U.S. forces, Hurricane Katrina and so on).

Nevertheless, it is possible to predict further movements of the trading instrument rate upon the planned release of economic indicators. For example, changes in statistical data on the unemployment rate will have a clear impact on the national currency exchange rate. At the same time, market response to the release of economic indicators follows a certain mechanism.

In your work we recommend using the economic calendar of events that you can find at www.forexpeoples.com.

Release of economic indicators from leading countries influences currency exchange rates to a different extent. According to their importance, such indicators can be divided into the following groups:

1. Very important

  • Gross-National Product
  • Trade deficit
  • Payment deficit
  • Inflation indices (Consumer Price Index [CPI] and Wholesale Price Index [WPI])
  • Unemployment and employment data
  • Money supply data (М4-М0 monetary aggregates)
  • Official discount rates
  • Parliamentary, congressional, or senatorial elections. Presidential elections (currency is influenced by election promises made by the candidates and historical preferences of the parties).

2. Moderately important

The exchange rate can sometimes react to this group of news. Everything depends on the specific situation on the market.

  • Size of retail sales
  • Size of housing starts
  • Size of factory orders and durable goods orders
  • Industrial production index
  • Producer price index [PPI]
  • Consumer price index [CPI]
  • Productivity.
  • Futures exchange rates
  • Deposit rates
  • Stock indices (Nikkey, Dow Jones, DAX etc.). Growth of these indices shows that national economics is in good state, and increases the demand for national currency of this country.
  • Dynamics of prices for government securities (T-bills, T-bonds).

Influence of the indicator on the currency exchange rate is shown in the Table below.

Indicator Change of indicator Change in national currency
Trade deficit Growth Drop
Payment deficit Growth Drop
Inflation indices: Consumer Price Index [CPI] and Wholesale Price Index [WPI] Growth Drop
Official discount rates (repo, Lombard etc.) Growth Growth
Gross-National Product (GNP) Growth Growth
Unemployment Growth Drop
Money supply data (М4, М3, М2, М1, М0) Growth Drop
Presidential or parliamentary elections Growth
Size of retail sales Growth Growth
Housing starts Growth Growth
Size of orders Growth Growth
Producer price index Growth Drop
Industrial production index Growth Growth
Productivity Growth Growth
Forward exchange rate
Futures exchange rate
Effective exchange rate
Deposit repos
Stock indices (DJI, NIKKEY, DAX, FTSE) Growth Growth
Prices of government securities (T-bills, T-bonds) Growth Growth

Release of fundamental data, as we have mentioned above, is a planned event, and according to existing international agreements, countries with leading economics are obliged to publish their projected and actual macroeconomic indicators. Bear in mind that the market takes projected indicators immediatelyinto consideration, and there is a possibility of a rapid market response if an economic indicator released is significantly different from that previously projected or when indicators from the previous periods are reconsidered. Predicting market response is challenging and requires practical experience.

Data from the fundamental analysis can and should be taken into consideration when developing trading strategies but only in combination with technical analysis data. Taking trading decisions based solely on fundamental data or shortly before the release of major fundamental data is unacceptable as the market response cannot be predicted. Besides, there is a practice where a planned release of an economic indicator leads to the re-evaluation of the previously published data on this indicator, which often reverses an overall response of the financial market. Let’s take a look at the example below.

The number of initial unemployment claims in the USA (data published every two weeks) at the moment of release was 418,000. The previous figure was 515,000 and the projected figure was 452,000. The number of initial unemployment claims filed is clearly less than expected, which indicates that economic situation has improved. The market would respond by rapid growth of the US dollar exchange rate against all other currencies by a certain amount (in practice, up to 50 points). Two minutes after the US dollar exchange rate has already started to move, a revision of the previous two-week-old indicator may be published, and the figure of 515,000 may be revised to 468,000. Then, the projected figure is little different from that released two weeks ago in terms of the absolute value, and the reverse reaction would follow returning the exchange rate to its initial level within a short period of time (approx. 10 minutes) or, alternatively, provoking a reverse movement. Commonly, a sharp increase in oppositely directed volatility of currency exchange rates may occur for a short period of time when a group of major macroeconomic indicators are released, followed by the price returning to the same level existing before the release of indicators.

Bear in mind that different macroeconomic indicators influence price movements of financial instruments based on different time intervals. For example, the ratio between discount ratesof State Central Banks is an indicator influencing global trends in the movement of currency rate ratio. The higher the discount rate of the State Central Bank is, the more profitable the investments in this currency are (however, consider inflation expectations). When the Central Bank changes the discount rate level, investors re-evaluate profitability of investments in this currency and refocus their interest towards another financial instrument. A similar situation exists with respect to the assessment of the market value of temporary CFDs for shares of the largest world holdings. The fundamental indicator is the profitability level of stocks (%) over the previous financial period. For assessment of investment profitability in the short term, investors use profitability reports over shorter (up to one month) time periods.

Methods of fundamental analysis are discussed in an easy-to-understand manner in the recommended literature.

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