Fundamental trading refers to the way in which a trader focuses on events specific to the company in order to determine which stock to buy and when to buy it. Trading on fundamentals requires a lot of research and wit, but the following insights may be able to help you learn how to do it more efficiently.
Trading Based on Fundamental Data
A huge slice of equity investors are aware of the most common financial data that are used in fundamental trading. Among these are earnings per share (EPS), cash flow, and revenue. These are quantitative factors that include any figure that is found on the company’s earnings report, balance sheet, or cash flow statement.
They can also include the results of financial ratios like return-on-equity and debt/equity. Fundamental traders may use these quantitative data to determine opportunities in times of unexpected events or potentially disruptive ones.
Earnings Announcement
The most important component of an earnings announcement is during the pre-announcement period. This is the time when the company issues a statement or guidance indicating its chances of meeting, exceeding, or failing to meet the earnings estimates or expectations.
Trades usually occur immediately after such an announcement because a short term momentum opportunity will likely be available.
Upgrades or Downgrades by Analysts
In a similar manner, analyst upgrades and downgrades may offer short-term trading opportunities, especially when a prominent analyst surprisingly downgrades a stock.
The price action in this kind of situation can be very wild so you should be fast and nimble when it comes to your short positions.
Earnings announcement and the ratings from analysts are closely related with momentum trading. Momentum traders look for unexpected events that may cause a stock to trade a large volume of shares and move steadily up or down.
For the fundamental trader, obtaining information on speculative events that the broader market may not be aware of is of great importance. To gain an edge, wise investors use their knowledge on the trading patterns that take place during events like acquisitions, takeovers, reorganizations, and stock splits.
Takeovers, Acquisitions, Reorganizations
When trading takeovers, acquisitions, and reorganizations, it’s usually wise to conform with the old mantra of “buying the rumor and selling the news.” During these events, the stock will usually experience extreme price increases in the speculation period leading to the event and significant declines right after the event has been announced.
For comparison, a corporate reorganization will probably be viewed as positive if it has not been anticipated by the market and if the stock has already been on a long-term decline because of internal corporate problems. If a board of directors ousts an unpopular chief executive, for instance, the stock may show short-term upward movement in celebration of the news.
Trading the stock of a takeover target is special because a takeover offer will usually have a related price per share. A trader should be careful to avoid getting stuck in holding stock at or near the offer price because the shares will commonly not move significantly in the short term once they find their narrow range near the target.
Especially in the situation where there is a rumored takeover, the best trading opportunities will be in the speculative phase, or the period in which a rumored price per share for the takeover offer will drive the actual price movement.
