When you buy stock in a company, how do you know whether that stock will go up or go down? Your first clue is the financial health, or “fundamentals” of the company. This is where fundamental analysis comes in.

Fundamental analysis is different from technical analysis because it focuses on what a stock’s price isn’t telling the market. Instead, fundamental analysts look at a company’s financial data as well as external data, like demand for a company’s goods and services or general economic trends.

Traders who use fundamental analysis look for the stocks of companies in good financial condition, with good prospects for growth and an appropriate level of debt. They then compare the company’s financial outlook with the value the market has assigned to its stock. If they feel a company is undervalued, they see it as a buying opportunity because the market hasn’t caught on to the true value of the company and its business. Since the market will ultimately value the company appropriately, trading the stock of a company that appears undervalued can be profitable. Similarly, if the market has assigned a price that higher than what its fundamentals suggest it should be, then this looks like a selling opportunity, because the market hasn’t taken notice of danger signals in the company’s financial outlook.

Since publicly-listed companies are required to announce and publish their quarterly and annual financial results, all market participants have access to the same financial information about a company at the same time.

In addition to looking at the financial statements of a company, fundamental analysis also takes into account factors like the performance of the economy, the nature of the company’s business, and the general prospects and challenges in that particular industry in both the short and long term. For example, rising raw materials costs could have an effect on the fundamentals of a manufacturing company – if the cost of its inputs goes up, its profit margins may shrink, or it may have to raise prices of its finished product, leading to lower sales and therefore lower revenue and profitability.

By helping you keep an eye on a company’s financial health, fundamental analysis can help you make profitable trading decisions by letting you take advantage of market inefficiencies in the price of a stock.