Fundamental analysis is one of the common methods used by investors to assess the risks and benefits involved with making short- or long-term market investments. It is a method of measuring the intrinsic value of a security and the factors that affect it. So, why and in what situations does fundamental analysis not work?
The reason fundamental analysis does not work is that it doesn’t provide an accurate short-term forecast, and only long-term investors can benefit from it. With short-term trades, fundamental analysis is not timely, and it hence fails to provide traders with actionable insights and data.
The rest of this article will help you understand the concept of fundamental analysis and the reasons and situations in which it does not work.
IMPORTANT SIDENOTE: I surveyed 1500+ traders to understand how social trading impacted their trading outcomes. The results shocked my belief system! Read my latest article: ‘Exploring Social Trading: Community, Profit, and Collaboration’ for my in-depth findings through the data collected from this survey!
Table of Contents
Understanding Fundamental Analysis and How It Works
The fundamental analysis comprises industry, economy, and company valuation/analysis. The stock analysis aims at determining whether a security is valued correctly within market borders. To identify the incorrectly priced securities in the market, fundamental analysis is done from a macro to micro angle. Public data is required in the valuation of security, such as stocks.
Analysts study the overall state of the economy, in order, and the strength of a particular industry before arriving at a fair market value and concentrating on an individual company’s performance. For example, an investor can carry out fundamental analysis on the value of a bond by assessing economic factors like the overall financial state and interest rates.
The trader can also look at information regarding the issuer of the bond and potential credit rating changes.
Fundamental analysis of stocks uses equity returns, revenues, future growth, and earnings to determine the underlying value of a company and its future potential growth. These data are usually found in the company’s financial statements such as balance sheets, income statements, and cash flow statements.
Whether you trade on futures, forex, or stocks, fundamental analysis will not improve your performance if your trading is short-term. The following are reasons why you shouldn’t concern yourself with it.
7 Reasons Why Fundamental Analysis Does Not Work
Fundamental Analysis Lacks Timeliness
For a day trader, what is happening right now is what matters, not what stock prices will be in years to come like for long-term investors. Charts make it possible to know price changes, what the stock prices are, and how they are changing at that moment. With fundamental analysis, company financials and economic indicators are released after a few days or after every quarter of the year.
The lack of frequency in these data makes it of less use to a consistent day trader. Instead of waiting to go through economic reports and financial statements, day traders use chart readings to find a trade setup and implement a trading plan. In this case, the fundamental analysis doesn’t work.
Fundamental Analysis Cannot Predict Short-Term Reactions
Markets randomly react to fundamental data points, whether commodity-specific/company or economic. For instance, in a situation where analysts expect that a company will generate one dollar per share in income, but the company produces an even higher amount. You would typically expect that stock prices will go up as a result. However, this isn’t always the case.
If traders were expecting an even better result, it could cause the asset’s value to decline. On the flip side, in scenarios where traders were expecting an even worse result, then even a bad result could result in your investment to increase in value.
Fundamental Analysis Is Incomplete Without Technical Analysis
If you’re a beginner at day trading, it might appear prudent to choose between the technical and fundamental analysis instead of both. However, this will be a mistake because both are the foundation of learning price movements. Without one, the other will be of little to no help, and sooner or later, you will fail in placing your trades. Simply put, without proper technical analysis, the fundamental analysis doesn’t work.
Fundamental analysis will help you understand the growing sentiments of both currencies in a pair and whether the prices are increasing or decreasing. Technical analysis will help you know when the timing is perfect for exit or entry points. To be a successful day trader, you need to know how to use technical and fundamental analysis instead of emphasizing just one.
One advantage of mastering technical analysis is that you will receive warning signs early when there are changes in market sentiments, allowing you to leave quickly. An easy way to balance both fundamental and technical analysis is by getting materials from different sources.
Fundamental Analysis Cannot Account For Market Overreaction
As you go about your day trading, you will most likely experience a drastic movement of prices in different directions. Such occurrences are usually as a result of fundamental news releases from US NFP (Non-Farm Payroll).
With these vital releases, there are fast reactions that prompt you to think many people are working. However, a second wave will suddenly show a lack of change in unemployment, and wages are the same.
As a trader, you should know that there will always be an overreaction in the market. At one time, the news will be good, but in reality, it isn’t good. High impacts in economic news releases will not always be a game-changer. Ensure that your money management is strong enough to withstand these sparks.
Fundamental Analysis Cannot Predict Supply and Demand
Day trading in the forex market requires trading currencies in pairs. This means that significant fundamental releases come from general resources and both sides of the currencies.
Demand and supply of securities in the market determine their price. Instead of focusing solely on fundamental dynamics that affect both currencies, pay attention to other factors that affect demand and supply. These factors include market sentiments and comprehensive market dynamics.
Other factors that do not involve fundamental data include natural disasters and geopolitical tensions. If an event impacts bonds, stocks, or commodities, then it will affect day trading. Although some will have minimal impact while others will pose a significant influence than economic releases, they will control the market sentiment for a period.
For this reason, price doesn’t always rely on fundamental analysis.
Weak Data Doesn’t Equal Bearish and Strong Data Doesn’t Equal Bullish
In this part, the ability to follow through with your trading plan will be tested. Through observation, you will notice when, for example, the USD and data related to GBP is strong. However, this could result from the GBP staying on hold instead of going downward, then moving upward.
This means that at the time, the GBP was stronger than the USD. Other than other economic releases, minor factors affect the price and imply that fundamental analysis doesn’t work.
Here is a video to help you understand the terms “Bullish” and “Bearish”:
Fundamental Analysis Can Be Irrelevant During Short Periods
Prices are always moving up or down; hence anything can happen in a short time in day trading. Day trading can last five minutes or less; therefore, a company’s balance sheet won’t matter a lot. The financial statements of a company can be horrible, but it will rally for months. Similarly, it can be financially strong and with excellent earnings, but share prices will drop on other days.
Anything can happen in one trade, and you need not distract yourself with the fundamentals of a company’s financial position as it can bias your trades.
Author’s Recommendations: Top Trading and Investment Resources To Consider
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Conclusion
Fundamental analysis evaluates the intrinsic value of assets such as stocks, bonds, and securities. However, it does not work in a variety of situations, for instance, short-term trading and other particular reasons. Fundamental analysis is unreliable without proper knowledge of technical analysis. It lacks timeliness and predictability in short-time frames, unlike charts.
Fundamental analysis can be irrelevant during short periods. It doesn’t work because of market overreactions when strong currencies don’t always outperform weaker ones—while weak data doesn’t equal bearish, and strong data doesn’t equal bullish.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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