Fundamental analysis is one of the three paths of study on the stock market. It is a useful way to determine whether the value of the stock will increase or decrease. Do note that some traders don’t rely on this type of analysis and they believe it isn’t accurate enough. If you are interested in finding out what this term represents and whether it is right for you then keep on reading.
Theoretical nature of the fundamental analysis
The goal of a fundamentalist (the trader that uses this type of analysis) is to find the real value of stocks. If you didn’t understand the previous sentence, then you know little about shares and their value.
The price of an asset you see on the stock market isn’t the real representation of its value. The number you see is the price that was determined by traders. The current share price is determined by the interest of the traders as well as historical values it had. It doesn’t represent the core value which is why fundamentalists perform research. Finding the intrinsic value of share requires analysis into the company as well as the comparison of its success against the success of other companies in the same industry.
The intrinsic value you come up with should be (in theory) the real value of the share. If it is higher than the current value, then the later has room for growth, and it’s smart to buy those shares. If the current price is higher than the intrinsic value, then the former will drop down, and it’s too risky to purchase those shares.
The human element versus the fundamental analysis
Fundamentalists rely on their form of analysis because it is logical. The only problem with this is that people aren’t rational and they will invest money even if the fundamental study shows that it isn’t the right move to make.
Few inexperienced traders will purchase a considerable number of shares even though they aren’t as valuable as they seem to be. They will do this just because someone said something about that company and they liked the idea of enormous profit. The current price of the share will increase as the higher number of people decide to buy invest in the company and buy their shares. This will happen even though the intrinsic value of the stock is several times smaller than the current one is.
The downside of fundamental analysis is that it doesn’t take human emotion into account. The Same thing prevents introduction of QProfit System like software into the world of stock trading.