Useful fundamental analysis requires a longer-term understanding of prices and inputs that can then be applied to short-term events. Fundamental traders do well when they can recognize the potential for a significant price move toward or away from equilibrium caused by a change in the underlying supply or demand. For example:
- A sudden weather event affecting crop yields and grain prices
- A sudden geopolitical event affecting oil prices or currency levels
- Long term demographic changes in population and wealth that will shift demand curves
The Importance of Fundamental Analysis
Understanding if a market is in surplus, deficit or equilibrium allows a fundamental trader to quickly interpret the changes in information that are constantly occurring.
For example, you probably will never know the exact equilibrium point for the price of wheat (although Wheat futures price is considered representative of that point at any given time). But, you can capitalize on a change in the price of wheat by understanding, analyzing and monitoring fundamental factors such as weather patterns, crop yields, consumer demand, government price subsidies, and import and export laws.
Supply and Demand
Fundamental analysts go to great lengths to understand supply and demand. They tap into vast sources of data, often from governments or industry associations that are charged with data collection, in order to make pricing decisions.
To be sure, there is an element of subjectivity that goes into constructing a trading model based on market fundamentals. The less bias and the better and more complete the data inputs, the more effective the fundamental model.
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