Fundamental Analysis and Spread Bettors

Having covered the “housekeeping” functions of spread betting, it is now time to describe how you can use the available tools to increase your understanding of the market, and to stack the odds in your favour when it comes to placing spread bets.

In financial markets, there are two types of analysis used – fundamental analysis, and technical analysis. This analysis is important because spread betters and traders in general commonly base their trading and investment decisions from studying the fundamentals (news and research) and the technicals (charts and graphs). Why type of trader are you? Do you look at charts and price statistics to make predictions or do you base yourself on social and economic news to formulate your trading strategies?

Before you decide to buy a stock, you face two key research tasks:

1. Fundamental Analysis:

Examining the company issuing the share.

2. Technical Analysis:

Evaluating the share itself.

Fundamental traders prefer to trade based on news and other financial and political data. Technical traders prefer technical analysis tools such as Fibonacci retracements and other indicators to forecast market movements. Some use a combination of the two. No matter what your style, it’s important to know how to use technical and fundamental tools to help you find potentially profitable trading opportunities.

In essence technical analysis makes use of a number of tools and techniques to analysis stock market price including charts, time frames and technical indicators to spot trends and forecast possible market movements. Technical analysis however disregards fundamentals such as news and economic conditions and is concerned only with the price action of the market. On the other hand fundmantal analysts tend to study factors like economic data and political events that may impact a company’s business and future prospects.

Both fundamentals and technicals are sometimes needed. You do not want to buy a share that looks priced at a discount, only to find out that the company is on the skids. On the other hand you don’t want to put money into an enterprise that is so hyped up that its stock has become overpriced. While fundamentals are very important for long-term buy and hold investors, short-term traders can’t simply disregard fundamentals because the market, particularly in the last few years, has become so reactive to fundamental factors.

In any case both technical and fundamental analysis provide ways of using the information at your disposal to forecast whether a particular market price is likely to rise or fall. Although fundamental analysis and technicals are similar in purpose, they are actually very different from a trading methodology perspective. Fundamental analysis involves researching all the financial facts about a company, including the value of the equipment owned, how much the company’s profit is each year after deducting expenses, and many other facts. One of the commonly used indicators that you may have heard of is called the P/E ratio, the price to earnings ratio. If it is out of line with other companies in the same line of business, then it is an indication that the share price should probably be different.

Technical analysts do not try to measure a stock’s intrinsic value, but instead utilise charts to spot price patterns. In examining the charts of forex pairs, industry sectors, commodities and individual shares, you can develop a picture of macroeconomic trends to assist you in your investment strategy. Indeed technical analysis is all about looking at charts and price trends since chartists believe that prices contain all the necessary information and that price trends tend to repeat over time. Daily, weekly, and monthly charts lend themselves well here and studying them could give you subtle hints on the longer-term trend of a market. There are also lots of different types of technical indicators available to stock market traders to assist them to make better trading decisions and these can play a useful role in providing signals for the momentum, divergence and reversal of trends. Some indicators are typically used in trending markets while others commonly referred to as oscillators serve a useful role in range-trading markets to overbought and oversold market stages, which can then be utilised to spot possible price reversals.

In this respect technical analysis is useful to make supportive trading decisions but understanding and following the company, its management and its proposals is more useful and this is where fundamental analysis gets into the equation. The only problem with fundamental analysis from a short-term trading point of view is that it only tells you what the price ‘should’ be, and not when or if the market will move in that direction. That is usually fine if you are investing for the long-term, as eventually you hope the market will realize what you have discovered, and the share price will become correct. But in the timeframe that you want to consider when spread betting or trading, this is not much help.

A fundamental spread trader would formulate a trade based on news happenings to which they believe the market will react. Fundamental analysts will check key elements that may have an effect on the strength or weakness of a particular forex pair or sharee such as economic data, political factors and even the impact of natural disasters. From Bloomberg and the Financial Times to MarketWatch and the Investor’s Chronicle, keeping informed of the latest market happenings can help you react more effectively to trading opportunities that present themselves. This line of thinking is not limited to company results and economic news either, and in practice fundamentals can include anything from weather forecasts to political developments. A City Index spokesman quoted a good example here: For example, if a particular British summer happens to get hotter than usual with frequent heat waves, a fundamentalist might expect an ice cream stock’s price to rise. On the other hand, if Britain was facing a dairy scandal, a fundamental spread bettor might very well expect the ice cream company’s price to fall.

Key indicators would include factors like inflation, interest rates, international trade, political situations and fiscal and monetary policies. For example, upbeat production and employment data may indicate a strong economy and would thus imply that the country’s currency is likely to strenghten, while negative economic data would indicate growing pressure on shares and currencies, thus putting downward pressure on prices. Fundamental analysis spread betting requires up-to-the-minute information and news update, as well as a good understanding of the ‘domino effect’ of various industry scenarios. For instance, when the USA non-farm payroll data recently exceeded market expectations, with unemployment in the United States hitting its lowest level for the last 3 years, this in turn investors’ appetite for risk, in the hopes of economic recovery which pushed the UK FTSE by 0.5% just after the release of the figures. Even then, fundamental spread betting has its flaws, as there so many factors that can affect the stock market that cannot be measured so risk management is key.

Fundamental Analysis Applied to the Forex Markets

While technical analysis is extremely important to determining ranges or trends in volatile markets, you should also understand the fundamental forces driving the markets. Major and minor economic announcements, not to mention political turmoil, can have profound impacts on a country’s currency, both in the short and long terms.

In essence, fundamental analysis in the macro sense is the study of the political, social and economic forces that drive the supply and demand trends of a particular currency. The market is huge and is made of diverse groups of people with different interests. The price you are seeing at any moment in time is the momentary consensus of the crowd at the moment of the transaction so when you are analysing the price you are in reality analysing crowd behaviour. Macroeconomic news drive the herd and can result in big moves in the market particularly in the sensitive market environment we are in at the moment where forex speculators attempt to predict central bank policy changes. However, in most instances it is better to trade on forecast figures since if the announced figures come out as the same as the forecast then there will be little movement to be seen. Obviously, if the real and forecasted figures are different this can give rise to dramatic price movements.

Traders can use this information to attempt to determine whether current or potential future conditions may drive the value of a nation’s currency up or down.

Many traders prefer to combine technical and fundamental analysis to help determine the proper market conditions for trading. Because most economic announcements are regularly scheduled, it is often easy to anticipate times when the market may be more volatile. While some traders choose to attempt to trade on news announcements, others prefer to stay out of the market due to the market’s unpredictable reactions.

The traditional approach is to learn about a company, check the accounts, assess the management and think through the potential market, and then invest for the long term if all looks acceptable. But due to the increase in market volatility one of the greatest forces in the markets today is sentiment and herd instinct.

How To Use Fundamental Analysis

Fundamental analysis assumes that at any point in time a company’s shares have an intrinsic value. This differs from the actual market value of the company’s shares on the stock exchange which may be the actual price that the shares are changing hands for but does not accurately reflect what they are really worth.

Intrinsic value depends on the earnings capacity of the company. If the current market value of the company is lower than the intrinsic value you assess then this tends to suggest that the share price will shortly rise. If the current market value of the company is higher than the intrinsic value you assess then this tends to suggest that the share price will shortly fall.

Stock market analysts use every piece of information that can be obtained from a company in order to support their fundamental analysis, including examining the company’s accounts, looking at its management, following the development of its products or services and carrying out market research to find out how consumers rate it. You can do all this if you wish to, but the easiest way to use fundamental analysis is to read their views and advice in the financial columns of many newspapers and magazines, as we have already discussed.

Fundamental analysis measures the strength of a company by studying the company’s balance sheets and financial statements. You can carry out your own simple fundamental analysis by examining several pieces of financial data for any company you are interested in and comparing it to the financial data for similar companies, as well as using it to assess the prospects of the market as a whole. In order to do this you will need to know the meaning of the following terms :

• Earnings Per Share (EPS) : EPS is the amount of profit per share from the ordinary activities of the company after tax. It is calculated by dividing the profits for ordinary shareholders by the total number of shares issued.
• Profit Margin : The profit of the company as a percentage of its sales.
• Return On Capital Employed (ROC) : The profit of the company as a percentage of its assets.
• Volume : The number of shares traded through the stock exchange. This can reveal whether (or not) investors are buying (or selling) into/out of the company.
• Dividend Yield : Dividend yield is calculated by calculating the gross dividend paid out by the company as a percentage of its share price.
• Price/Earnings Ratio (P/E) : The P/E of a share is a way of comparing the cost of buying into the earnings or dividends that share produces. To calculate it first divide the after tax earnings of the company by the number of shares (the earnings per share) and then divide the current market price by this amount.
• Net Asset Value (NAV) : The amount shareholders would be likely to receive should the company cease trading and be liquidated.

Remember that you do not necessarily need to calculate this information for yourself as most financial newspapers and software programmes provide it for you.