Fundamental Analysis Getting Started Trading with Fundamentals

Most traders tend to use technical analysis to pick their entry and exit points when trading, and swear by those methods, but if it were really that good why are there so many variations? More importantly, why do so many technical traders lose money? The answer is quite simply that they are using charts to predict the probable future price movement, based on patterns. Now that is okay but it is only slightly different from a gambler who might say that, based on the fact that there are 36 number cards and 16 face cards (excluding the 10s), there is a 9/13 chance of drawing a numerical card and as such he will place his money on that.

Now that is acceptable if one were to view the accumulation of wealth as a gamble, but for the serious investor and trader, there has got to be a lot more than probabilities. I recall visiting a gambling website on the evening that England were playing Columbia in a recent friendly; as most people know you could place a bet on either team to win or you could wager that the match will end in a draw. Unfortunately, if your forecast were to turn out wrong you lose your money. But that is gambling and as they say: "You pay your money and you take your chances." However, there is an alternative way of making sure, easy and guaranteed money - it just requires a bit of work. In this case, by simply calculating the odds, the astute would have been able to work out that one could have placed bets on all three outcomes simultaneously and made money regardless of the outcome, albeit a return of only 3.5% to 4.8% of the total wagered. But a wise sage once said that nobody ever went broke taking a profit. The reason I use this example is to emphasise the point that even when one is involved in riskier markets/ventures it is still possible to make money with minimal risk.

This is where the fundamental trader comes into his own and, contrary to popular belief, one need not be a genius to be able to grasp and understand the way things work. What is required in any market is to be able to determine the price level at which an instrument is cheap, fair value or expensive. Based on the fact that I choose to trade shares and occasionally the UK and US indices, I will base this article on these instruments, but in truth, the same theories apply across most if not all markets.

Given that shares are a share of a business it stands to reason that as long as the profits keep going up and the cash registers keep ringing; the shares will follow suit. A very crude example is that if I own 10% of the local supermarket and the profits double over the next 5 years, I will expect my original investment to double as well (all things remaining equal).

The value of quoted shares is determined by supply and demand and whenever one or the other moves out of line, the price will end up being too low or too high. How do we determine this?

Let us assume that I am currently looking at the shares of Barclays Bank. I would start by comparing it with other banks such as HSBC, LloydsTSB, Royal Bank Of Scotland and NatWest. If we assume that the average PE ratio (price divided by earnings) of the banking sector is 12, then at any level higher than that Barclays shares are relatively expensive and at any lower level they are relatively cheap. I would now move on to another yardstick, which might be the dividend yield, and we might assume that the average yield of the banking sector is 3.8%. If Barclays shares currently yield 4.2% then they are relatively cheap on a yield basis and if they only yield 3% they are relatively expensive. There are other ratios that might be used like the Return On Capital Employed (ROCE); Book to Sales; Net Asset Value; Earnings Before Interest Tax Depreciation and Amortisation (EBITDA). The last one is, in my opinion, an absolute nonsense and one is better off ignoring it when trying to calculate fair value: it is a legacy of the Dot Com era (and a bad one at that).

If we were to assume that Barclays has a PE ratio of 10 and a yield of 4.2%, then so far so good, the next thing to take into consideration would be the company's growth prospects. The best thing to do is check the last 3 years results, which might show that it has an average growth rate of 15%. Dividing the PE ratio of 10 by the growth rate of 15 gives a figure of 0.66, this is known as the PEG ratio (any figure below 1 is generally good value).

It seems that I am on to a winner here and the last thing I would need to check before I place the buy order is that the economy is not about to collapse bringing a substantial rise in bad debts. Once I am happy that this will not happen I buy the shares in the knowledge that sooner or later, the market will wake up to the fact that the shares were previously under priced.

The whole procedure above takes less than 30 minutes and a smart 15 year old could perform this basic exercise. The beauty of it is that you would not have lost any money during the Technology bubble. Some people were buying shares that were priced based on the number of times people viewed the website. Hello? Why would I buy a fashion boutique based on the number of people that look at the mannequins through the window? It is all about sales, cash flow, profits and assets. Why would any rational thinking individual pay 1000 times earnings or 100 times sales for a company that has no assets, that was started within the last 12 months and is run by a couple of high school dropouts? The astute were busy snapping up the cyclicals, utilities, mining, banking stocks etc. that were extremely cheap on fundamentals and yielding more than bank deposits. When the music stopped, the technology speculators ended up without chairs (and in some cases they lost their beds as well).

By the time the charts told them the shares were heading for the abyss, it was too late, somewhat akin to trying to flee from a tornado or tidal wave. Ask yourself if you would put your boat out to sea if you knew that this would occur: obviously not. Neither would you head for the ski slopes if you had been told about an impending snowstorm. Fortunately, fundamentals are like the weatherman: you receive advanced warnings of the impending direction of the markets.

Whenever I see shares that are way out of line with their fundamentals I latch onto them and get ready to pull the trigger. It does not always have to be a case of buying (going long), it could be selling (shorting) - one simply reverses the criteria. A good example is Google: the speculators are piling in as if they are the best thing since sliced bread and they are currently priced around $293 per share. Now if I did not consider them good value at $115, $150, $180, $200 or even $250, why would I buy them at $293? I am either a momentum trader along for the ride, a technical trader following the steep gradient on my chart or a fool looking for gold. Before anyone says "But what about the massive profits that could have been obtained?" remember that trading with hindsight is impossible. More importantly, I used to do some work for a bookmaker and he once said, "Son it is not about the winners that you miss but the losers you do not back." These shares are strictly for gamblers and those that have a high pain threshold and in my opinion there are much better trades elsewhere.

Trading based on fundamentals may not be exciting and you are very unlikely to grab any headlines but you certainly will not be parted from all your money. Sure and steady capital growth will be your reward and you will sleep well at night. I often laugh when I hear people say that they cannot leave trades running overnight because their stops might get hit but that is because they are taking on unnecessary risk. (Am I buying shares in BP or Exxon because they are good value or because I believe oil will hit $75 per barrel? Oil reaching those lofty levels should be a bonus). Sound trading based on fundamentals does not require tight stops: whenever they are hit, it means that the analysis was wrong or the company's fundamentals have changed. You take the knock on the chin and move on because there are lots more fish in the sea.

On a final note, one does not require deep pockets to trade in this manner, as one can use spread betting which offers gearing of at least 10:1, CFDs which offer 5:1 or outright stock purchases. Depending on the method used and the number of open positions, it is possible to start and be profitable with as little as £2,500 starting capital (or something in that region). If one is astute it is quite feasible to compound the money and turn it into a large amount of capital.
 
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An excellent discussion which now appears exhausted. So perhaps now is the time to take it a little further if anyone wishes.
A little background first. Several years ago in the mid 90s I looked at shares for the first time and taught myself fundamental analysis from books. I became reasonably proficient but didn't have the capital to be able to utilise my developing skills sufficiently. At the same time I came to realise that much of what should happen, doesn't. I then looked at the other side of the coin, technical analysis, which showed me sentiment as well. Or at least the way I used TA did, but that was unlike in any TA book. It was based more on looking and thinking and then seeing what actually happened in the real world, not my opinion.
I won't bore anyone with any further details except to say that it became very obvious to me that a combination of the two, FA and TA, was to see things in the round, in the whole. More importantly I realised I could increase my funds much faster by an integrated approach which involved a simple understanding of the significance of fundamental news stories pre-market in the US and, crucially, how to successfully and consistently trade them intra-day.
Every day I read the fundamental news stories pre-market, compile a list of 4-10 and normally end up trading some of them according to my own patterns and rules.
Take today, Goldman Sachs came out with news before the market opened which placed it on my watch list. I could have profited from its early move but I was busy with another stock. However, this evening it presented a set up which has a very high percentage success rate and I traded it for a profit of $1.24 per share, strictly adhering to my rules of entry and exit. There was no level 2 involved.
"The news is in the price" is total nonsense, otherwise everything would flat line. It is the reaction of traders and institutions which moves price. Price has little relation to value. It is simply the meeting point of supply and demand at any particular time.
The return on capital employed was 1.22% in 75 minutes - without any gearing. If I had chosen to take up the four fold gearing facility in my account, the return would have been 5% - though such gearing calculations are essentially meaningless - an arithmetical construct. The risk was 15c-20c maximum with a very low %age probability of that stop being hit. I have no overnight risk whatsoever and can exit a trade within seconds. My funds are being sweated to produce the maximum return and I am in control as much as is humanly possible.
So, big deal, you might say. The point is that you can combine an understanding of fundamental analysis with reading the market intra day and make profits disproportionally greater than using purely FA or TA.
In my opinion, anyone who only uses FA or TA, or who deprecates one against the other, is simply not being as efficient as someone who uses both in an integrated, understanding way.
Of course, anyone in a day job can trade the US in the evening, as in the example GS trade mentioned above.
FA versus TA is an artificial construct and those who spend precious time arguing for one over the other are simply not employing their time efficiently - all in my opinion only, of course.
Richard
 
FA or TA, they are both of the upmost importance, depending on instrument and timeframe. This is a bit off the subject, but, going back to what Mr C says, 'market gearing'? Is there really such an instrument or strategy that will offer more for less than anything else? I.E. Options v's Futures? As far as i am concerned there is nothing on the markets that can offer a better return than the other, if traded RIGHT! The market has only one 'real' 'gear'? Anythoughts, RB.
 
Mr Charts,

Would I be right in saying that you started studying TA out of necessity due to a lack of capital? Are you also saying that you had a decent understanding of FA at the time? If the answer to the two questions is yes, I would say that you were able to marry the two due to a desire to surmount the only handicap you had at the time.

You then proceeded to develop a method that was/is unique to yourself without bias or misconceived perceptions about what does or does not work. The blending of the two enabled you to develop an edge that produces regular profits.

Research and practice always bring rewards and make the trader better; the fact that you have been able to apply this successfully to day trading is even better. The reason most traders will find it difficult to emulate you is that they have a bias against FA or TA. This tends to be borne out of ignorance of the facts.

I sometimes indulge in similar practices to the one you have mentioned and find them quite rewarding. As mentioned, the markets are random and inefficient, albeit sooner or later they come in line with fair value. The problem is how long is sooner or later and what is the opportunity cost?
 
Lion 63. If the markets were to be inefficient, would that be in a 'lagging' or 'leading' or just 'disruptive' or 'chaotic' type of way? As far as i am concerned the markets are always 'very' efficient. Like you suggest, it is the reading of markets that is 'chaotic'. Although, saying this, the best the markets ever become is a 'three way split', 'Buy', 'Hold' and 'Sell'? Trying to blend these is even more 'chaotic'? Hope this makes sense? RUDEBOY. P.S. As a 'trader' i really need to focus on investment?
 
LION63 said:
Mr Charts,

Would I be right in saying that you started studying TA out of necessity due to a lack of capital? Are you also saying that you had a decent understanding of FA at the time? If the answer to the two questions is yes, I would say that you were able to marry the two due to a desire to surmount the only handicap you had at the time.

You then proceeded to develop a method that was/is unique to yourself without bias or misconceived perceptions about what does or does not work. The blending of the two enabled you to develop an edge that produces regular profits.

Research and practice always bring rewards and make the trader better; the fact that you have been able to apply this successfully to day trading is even better. The reason most traders will find it difficult to emulate you is that they have a bias against FA or TA. This tends to be borne out of ignorance of the facts.

I sometimes indulge in similar practices to the one you have mentioned and find them quite rewarding. As mentioned, the markets are random and inefficient, albeit sooner or later they come in line with fair value. The problem is how long is sooner or later and what is the opportunity cost?

No, that was not the prime reason. It was the weakness of FA to present the whole picture combined with a thirst for knowledge about what was missing. It would be immodest to say my understanding of FA was comprehensive, so I won't.
The anti-TA or anti-FA bias is a problem for most people, but the largest problems most people have in day trading is their belief it is very easy, their belief in themselves, their pre-conceived notions of FA and investment colouring their attitudes and, for many, their lack of self discipline and application.
I don't want to get into a debate with you about the concept of random walk theory and inefficiency as it would be futile. I can tell from your postings I could never convince you of the errors of your ways ;-))
Richard
 
Rudeboy,

I believe that Mr Charts has to a large extent answered your question about market efficiency or the lack thereof. What I mean by this is that you can see we are on opposite sides of the debate and it is one that could go on and on between both camps; as such you will have to decide which side you plump for or agree with based on your knowledge and experience.
 
LION63, FA or TA, i do not disagree with any! Why has this thread become an arguement? The only thing i have ever said is that FA has it's limitations as oppossed to TA! This is not a slur, it is the truth! RB.
 
If what i have said is glaringly obvious! What is the point of comparing FA to TA in the first place? FA in itself should be understood! Rude.
 
The original thread came over as an arguementitive stance in the first few sentences! Rude.
 
Rudeboy, I have not argued with anyone and do not believe that anything will be achieved if I did. The markets are very vast and there are millions of participants that believe in different instruments, analysis, criteria, time frames, gearing etc.; it is not for me to force my opinion on others. All I have tried to do is show that technical analysis is not the beginning and the end.

If I have not achieved anything else, I have attained my primary objective. In a little over 2 days there have been over 1,500 viewings of this thread, that means that people have at least taken a passing glance and hopefully some of the newcomers to trading will benefit from it.

I cannot and will not say that fundamental analysis does not have limitations - of course it does. But you will not see many fundamental traders in the poor house, neither will you hear them talking about 60% strike rates or very tight stop loss levels. As for profit percentages per trade or return on total capital, it depends on what the individual is looking for. Personally I aim to get rich slowly but surely without losing any sleep, worrying about market gyrations or having a cardiac arrest because prices are bobbing up and down.

It is not for me to castigate those who would choose otherwise as they are not looking after my pension. If they want to shoot for the stars, ride the crest of wave or anything else that provides a rush of adrenaline they are free to choose.

There are technical traders that are very good at what they do but most are simply gambling which is why they require tight stop losses to cushion the blows when they get it wrong (very often). Listen to what is said whilst they are still observing the charts - If it does X then Y will probably happen but if it does A there is high possibility that B will occur.

I totally agree with what you say that "FA has it's limitations as opposed to TA"; in that FA will not put you in the bankruptcy courts whilst TA in the hands of a poor trader will hasten his/her financial demise.
 
LION63, i am sorry if i have put this thread off track? O.K. here is a question! FA is done by the 'BIG BOYS', and the volume is apparent.......TA boys, can they have a go now? Rude.
 
You only have to look at the numbers, most of the members on these boards (at least 95%, probably more) are technical traders and they must do large numbers of trades between them so they are already having a go. They must be a very fair reflection of traders out there and numbers do not lie. Some work/have worked for various institutions that have large sums of money traded on a technical basis yielding their customers decent returns on a yearly basis. There must be few bulge bracket firms that trade on this basis and the staff and investors are quite happy.
 
LION there are two statements you have made above that have caught my eye:~

The first one is; "Listen to what is being said whilst they are still observing the charts".etc.,

And the second one; "so they are already having a go".

Your descriptions are so apt and terribly funny. I have one of my people visiing this evening. We are sitting in here and choking with laughter at the idea of these peoples' pointless and endless disseminations and arguments.

This is because none of them really know what it is they are doing. One relies on the other in the belief the other one knows, but in the end analysis neither of them really know anything.

This is both funny and dangerous.

I can only liken it to an attempt, to ride a penny farthing bicycle wearing a full suit of medieval armour in the middle of the rush hour going round Hyde Park Corner !
 
MrCharts



More importantly I realised I could increase my funds much faster by an integrated approach which involved a simple understanding of the significance of fundamental news stories pre-market in the US and, crucially, how to successfully and consistently trade them intra-day.

Right up to this point, I was ok.
Now, unfortunately what you are advocating in this paragraph is not "Fundamental analysis" in any shape or form. ( intergrated approach ) it is quite simply looking for stocks with "NEWS" that will cause some volatility.

Understanding the significance.....................
If you mean by this, understanding that it may cause an increase in volatility, then why not just say so, and not dress it up to be something it is not.

Because if you are saying you can take the "News" and calculate from the Financial Statements what will happen intra-day, you are misleading your audience.


Take today, Goldman Sachs came out with news before the market opened which placed it on my watch list. I could have profited from its early move but I was busy with another stock. However, this evening it presented a set up which has a very high percentage success rate and I traded it for a profit of $1.24 per share, strictly adhering to my rules of entry and exit. There was no level 2 involved. "The news is in the price" is total nonsense, otherwise everything would flat line. It is the reaction of traders and institutions which moves price. Price has little relation to value. It is simply the meeting point of supply and demand at any particular time.

Presented a set-up that has a high % success rate.
Research studies that show this?
Or just your personal finding based on 1000's, 10,000's, 1000,000's of trades?

The reaction of traders, & institutions move prices....................agreed.
Price has little relation to value.

If you are a daytrader, agreed, which negates your integrated approach does it not?
If you are a Value investor, then it is an integeral consideration of every trade decision.

Meeting point of supply & demand.
Twaddle.

Daytraders, by definition do not hold stocks for any length of time.
Any Specialist or MM worth his salt, has a pretty accurate idea as to the % of his inventory turns over each day with daytraders.

The MM wants "VOLUME" as this is how the "EXCHANGE" generates revenue ( 1 of )
Therefore the greater the volatility of the stock, the greater the # of daytraders will be drawn to his stock.

Of course if "News" from the "Business" actually is released, then he is helped as more will be watching for increased activity or VOLUME, but this has nothing to do with Supply & Demand, as the shares will all be returned to him at the end of the day.

Save, those bought by longer term traders or investors.
By studying his inventory and his order book, he will be able to gauge true S&D.
Studying volume will not advance your knowledge one jot, unless you have far more information, which is highly unlikely.

The return on capital employed was 1.22% in 75 minutes - without any gearing. If I had chosen to take up the four fold gearing facility in my account, the return would have been 5% - though such gearing calculations are essentially meaningless - an arithmetical construct. The risk was 15c-20c maximum with a very low %age probability of that stop being hit. I have no overnight risk whatsoever and can exit a trade within seconds. My funds are being sweated to produce the maximum return and I am in control as much as is humanly possible.

What I find interesting is the sudden switch to a % based return.
GS closed at $102.65

What % of total Capital did you use? Without this figure, just quoting a 1.22% return is meaningless.

If you used 100% of your trading capital, then a very nice return.
If you used 5% of your capital, while not a complete waste of time, not really worth the effort, as 5% * 1.22% = not very much.

That you suggest a substantial % of funds utilised by the comment,............"sweating them" what would you do in the case of the Stock being suspended from trading?

You could be seriously hurt, if when it resumes trading it "gaps" seriously against you.
Your trading plan is just so misleading, and dangerous for novice traders, that I question whether it is advice, or an advertorial you are posting here.

So, big deal, you might say. The point is that you can combine an understanding of fundamental analysis with reading the market intra day and make profits disproportionally greater than using purely FA or TA.

You are not utilising an FA approach at all, just momentum as usual. At least be reasonably accurate in your posting. Intra-day & Fundamentals are not a happy mix.

In my opinion, anyone who only uses FA or TA, or who deprecates one against the other, is simply not being as efficient as someone who uses both in an integrated, understanding way.

It is your opinion.
To my mind you have provided no evidence of analysis of a fundamental nature within a daytrading context with which to support your opinion. You use "news" to identify potential VOLATILITY, this is not a fundamental analysis, this is just a screening technique that many software systems provide.

FA versus TA is an artificial construct and those who spend precious time arguing for one over the other are simply not employing their time efficiently - all in my opinion only, of course.

To my mind they are fundamentally different. You will waste your time trying to integrate them, they are as different as night and day. What you may see, is a confluence of analysis in a specific set of circumstances, and this can be traded, but it is certainly not on an intra-day timeframe.

cheers d998
 
Mr D,
"To my mind they are fundamentally different. You will waste your time trying to integrate them, they are as different as night and day. "

I'm surprised to read this from you.....at the very bottomline trading is all about a psychological numbers game and both FA and TA are simply organisational tools for helping us to engage in that game ...whether they are effective or not appears to me to depend only on how much understanding the user has of these tools and how to use them ...and for clarity we're not talking about a newbie techie who thinks a ma xover is the holy grail ..or a fundie who thinks a P/E tells him all he needs to know about a company ...we're talking about how to use these tools to sharpen our ability to select only the best trades and leave the rest to those mentioned above ..let them pay us to take a risk ..in other words we become the house on a probability basis...seriously I think you are in danger of letting your bias worn underskirt show ;)

Cheers
 
CHUMP

I'm surprised to read this from you.....at the very bottomline trading is all about a psychological numbers game and both FA and TA are simply organisational tools for helping us to engage in that game ...whether they are effective or not appears to me to depend only on how much understanding the user has of these tools and how to use them ...and for clarity we're not talking about a newbie techie who thinks a ma xover is the holy grail ..or a fundie who thinks a P/E tells him all he needs to know about a company ...we're talking about how to use these tools to sharpen our ability to select only the best trades and leave the rest to those mentioned above ..let them pay us to take a risk ..in other words we become the house on a probability basis...seriously I think you are in danger of letting your bias worn underskirt show

Two things move markets.
Fundamentals, & Emotion, ( or Psychology. )

Fundamental analysis attempts to measure, or value the business underlying the stock ticker.
Technical Analysis attempts to measure market sentiment.

Only under certain conditions do the two forms of analysis blend ( and this is in large part what my article is about )

Therefore, by mixing and matching, you will have conflicting messages, and this will blur the rules in your trading plan. Blurred rules usually result in disaster.

This is not to say you cannot master both techniques, and employ them seperately in different trades...........say trade GOOG as a technical, and NEN as a fundamental.

I would never trade GOOG at the current price with a fundamental viewpoint.
If I were to, I would be SHORT, but hell if it's gone to $299 it could go to $599, or $899 who knows, so I just stay well away.

For MrCharts to claim a Fundamental calculation, or input, was a component of an intra-day scalping trade is just absurd. A complete nonsense.

Cheers d998
 
ducati998 said:
CHUMP



Two things move markets.
Fundamentals, & Emotion, ( or Psychology. )

Fundamental analysis attempts to measure, or value the business underlying the stock ticker.
Technical Analysis attempts to measure market sentiment.

Only under certain conditions do the two forms of analysis blend ( and this is in large part what my article is about )

Therefore, by mixing and matching, you will have conflicting messages, and this will blur the rules in your trading plan. Blurred rules usually result in disaster.

This is not to say you cannot master both techniques, and employ them seperately in different trades...........say trade GOOG as a technical, and NEN as a fundamental.

I would never trade GOOG at the current price with a fundamental viewpoint.
If I were to, I would be SHORT, but hell if it's gone to $299 it could go to $599, or $899 who knows, so I just stay well away.

For MrCharts to claim a Fundamental calculation, or input, was a component of an intra-day scalping trade is just absurd. A complete nonsense.

Cheers d998

This is another fabulous assortment of pronouncements you have made here, ducatty, and another one for my pinboard....Marvellous !
 
ducati998 said:
Two things move markets.
Fundamentals, & Emotion, ( or Psychology. )

Actually, buying and selling are what move markets. One could even say that the intent to buy/sell also moves markets in that the bid/ask (which exists in every market) is a reflection of transactional intent.

What I think you mean is that fundamentals and emotion (psychology) lead to buying and selling (or the intent to do so). They do, but so do technicals (among other things). If I am employing a break-out strategy, then my buying/selling is technically driven. Could it be that the price move creating the break-out is fundamentally and/or emotionally driven? Absolutely. But my contribution to the mix (as small as it might be) is not. And given the number of technical trader around, one has to include that in the mix. That is why technical analysis is sometimes referred to as self-fulfilling.
 
Rhody

What I think you mean is that fundamentals and emotion (psychology) lead to buying and selling (or the intent to do so).

Indeed.

They do, but so do technicals (among other things). If I am employing a break-out strategy, then my buying/selling is technically driven.

And you would seem to be arguing that the "Breakout" could be caused by;
Fundamental reasons,
Psychological reasons,

But your technical entry is based on the "pattern".
Thats fine, I can accept that.

That is why technical analysis is sometimes referred to as self-fulfilling.

In which case I also would accept your conclusion.
Cheers d998
 
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