Basic knowledge of analysis
Analysis methods
Although the goals of fundamental and technical analysis are almost the same – identifying and reducing risks and predicting the direction of expected exchange rate movements in order to achieve the highest possible profit – they are completely different in their methods and tools. While in the case of the former, we live with the assumption that the development of exchange rates is basically determined by fundamental factors and we make our decisions after examining these, i.e. current political, economic events, and financial indicators, in the case of the latter, the analysis is basically based on mathematical and statistical foundations.
It is important to emphasize that neither the use of fundamental nor technical analysis guarantees that our investment will be successful in the end.
Fundamental analysis is mostly used to examine stock prices. Followers of the method look for the answer against the background of exchange rate movements, during the analysis they concentrate on the management bases, financial results and indicators of the companies - company-level analysis - but at the same time they also pay attention to the macroeconomic and industry environment. Fundamental analysts try to determine the "intrinsic value" of companies, on the basis of which they determine which investment opportunity (company) is undervalued or overvalued, and make a buy or sell recommendation. Considering that in the short term there can be a significant difference between the intrinsic value of a share and its current market price, the application of fundamental analysis is really relevant for long-term investments.
When determining the value of a company, the fundamental analysts are the following indicators are examined:
• Profitability indicators (ROA, ROE, ROS): They show what kind of return the company can achieve.
• Efficiency indicators (stock, customer, supplier turnover rate): They show how efficiently the company uses its assets.
• Capital ratio indicators (equity ratio, interest coverage): They indicate the indebtedness of the company.
• Liquidity indicators (liquidity ratio, money ratio, duration indicator): They show the company's solvency.
• Market indicators (market capitalization, P/E, EPS, P/BV, dividend yield): They show how investors value the company.
The fundamental analysis of foreign exchange markets (Foreign Exchange or FX markets) is very complex, as the value of a currency is determined by a number of fundamental factors, including the relative interest rate and inflation level characteristic of the given currency, the performance of the economy in question (typically measured by GDP), and in addition, it can be influenced by other macroeconomic indicators as well as the objectives of monetary policy. Due to its complexity, this analysis method is used in the FX market only for determining long-term trends.
Technical analysis
Using technical analysis, investors try to predict the direction of changes in markets and exchange rates, taking into account past and current market prices and turnover. To determine possible outcomes, different patterns are identified (head-shoulders pattern, flags, triangles, etc.), various indicators (moving averages, oscillators, etc.) are used. While the identification of the shapes is somewhat subjective, the indicators can be calculated based on mathematical/statistical formulas. Many trading strategies are based on the use of indicators.
The most important basic assumptions of technical analysis:
1. The market price "includes everything":
In
other words, the current market price, in addition to the supply-demand
relationship, also reflects all information known to investors and
future expectations. When analyzing the markets and determining the
expected direction of the exchange rate, the market turnover also plays
an important role, which we regard as an internal characteristic of the
market.
2. History repeats itself (History repeats itself):
One of
the basic theses of technical analysis, which starts from the
assumption that investors follow similar patterns of behavior in similar
situations. In fact, the development of the system of technical
analysis is due to the study of these behavior patterns. The idea is
based on observations about mass psychology discussed in psychological
studies.
Differences
One and perhaps the main difference is that in the case of fundamental and technical analysis, the information comes from completely different sources. In the case of fundamental analysis, investors mainly obtain information from company (quick) reports, and in the case of technical analysis, from the pair of price chart turnover. An important difference is that the followers of fundamental analysis think in the long term, often years, while those who believe in technical analysis have a significantly shorter time horizon, often only a few weeks or days (daytrade), but hourly or minute-based trading is not uncommon either. Despite the essential difference between the above methods, the two approaches complement each other well. While fundamental analysis is the "What?" answers the question, i.e. which asset (stock, bond, currency, raw material, etc.) is worth investing in (or which one is worth getting rid of), while technical analysis answers the question "When?" helps you decide. The levels that can be identified by the method of technical analysis and the indicators used help to decide on the question of undervaluation and overvaluation, as well as to determine the stop-loss and take profit levels. Trading solely on the basis of fundamentals is suitable for those investors who are ready or able to tolerate a relatively large, unrealized loss even for a long time, trusting that their insights related to the fundamentals, their assessment of the situation, and the decision made on this basis are correct, and the the exchange rate of a given asset will eventually develop favorably for them. Investors who trade only on the basis of technical analysis, on the other hand, typically take short-term positions and expect quick profits from the method.