There are generally two approaches that are employed when analysing capital markets; Fundamental Analysis and Technical Analysis. For example, when trading or investing on the stock market, there is need to appreciate that companies do not operate in isolation given that they operate within an industry and broader economy. In this article, Piggy will focus on fundamental analysis and how it can be used to anticipate trends and identify opportunities.
Fundamental Analysis is a broad study of the economic and political forces that determine the price levels of an asset. This includes stock prices, exchange rates and even property prices. Like any other price, supply and demand dynamics are critical. By forecasting how these forces will change and develop over the medium term, one can forecast how price levels will move.
Supply and Demand
Typically, more demand for a good or service causes its price to increase. Less demand causes the price to decline. Greater supply for something usually leads to a lower price. Less supply leads to a higher price.
Imagine we all want the new Mercedes Benz model, but it is a limited edition. Only 500 have been made globally.
Is the price of that car likely to be high or low?
The price of that car is likely to be very high, because lots of people will be chasing after a limited amount of cars.
But what happens to the price if Mercedes Benz suddenly announces they will produce another 50,000 of the specific model?
The price will probably decline, as more cars are available to the market.
A farmer in a small village produces tomatoes. He is the only one producing tomatoes there and the village is relatively isolated. In 2019, the weather was excellent. He managed to produce 1,000kg, more than enough to feed the whole village. He sold every kilo of tomatoes for USD1.0 in that year. However, in 2020, the weather was rather bad. He only produced 200kg.
What is likely to happen to the price of every kilogram of tomatoes?
Prices will probably go up. Everyone will want tomatoes but there may not be enough of them to go around. This means that each person would be willing to pay a higher price for potatoes.
Apple has just released its brand new iPhone 12. What will probably happen to the price of the iPhone 11?
Most likely, it will go down. This is because Apple’s cost of making an iPhone 11 did not change dramatically overnight. But the fact that people now want the iPhone 12 suggests there is less demand for the previous version. Piggy highlights that understanding the forces of supply and demand is critical when analysing markets.
This is applicable even on the stock market whereby the supply and demand of shares or script is critical in understanding price trends.
The Demand Curve
Chapter 2 of the Investment 101 handbook provides a thorough overview of economic factors that determine the demand and supply of underlying assets. Download a Copy of the Investor 101 Handbook below;
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