FOREX - Introduction to Fundamental Analysis

Fundamental analysis refers to the flowing tide of political and economic conditions that may affect currency prices. FOREX traders using fundamental analysis will primarily have to rely on news reports to gather information about unemployment rates, economic policies, inflation, geo-politics, and growth rates.

Fundamental analysis is often used by many traders in order to get an overview of worldwide currency movements and events, and to provide a broad picture of economic conditions affecting a specific currency.  Most traders will rely on technical analysis for plotting entry and exit points into the market and supplement their findings with fundamental analysis. 

Currency prices on the FOREX are most commonly affected by the basic forces of supply and demand, which in turn are affected by economic conditions.  The two most important economic factors affecting supply and demand are interest rates and the strength of the economy.  The strength of the economy is affected by the Gross Domestic Product (GDP), foreign investment and trade balance.

Fundamental Indicators

Two of the most important fundamental indicators are interest rates and international trade.

Other indicators include the Consumer Price Index (CPI), Durable Goods Orders, Producer Price Index (PPI), Purchasing Manager's Index (PMI), and retail sales.

• Interest Rates  These can have either a strengthening or weakening effect on a particular currency.  On one hand, high interest rates attract foreign investment which will strengthen the local currency.  On the other hand, stock market investors often react to interest rate increases by selling off their holdings in the belief that higher borrowing costs will adversely affect many companies.  When stock investors sell off their holdings, this may cause a downturn in the stock market and the national economy.  Determining which of these two effects will predominate depends on a mix of many complex factors, but there is usually a consensus among economic observers of how particular interest rate changes will affect the economy and thus the price of a given currency.


• International Trade  A trade balance which shows a deficit (more imports than exports) is usually an unfavourable indicator.  A deficit trade balance means that money is flowing out of the country to purchase foreign-made goods and this may have a devaluing effect on the currency.  Usually, however, market expectations dictate whether a deficit trade balance is unfavourable or not.  If a county habitually operates with a deficit trade balance this has already been factored into the price of its currency. Trade deficits will only affect currency prices when they are beyond this range of normal market expectations.

Other indicators include the Consumer Price Index (CPI) which is a measurement of the cost of living, and the Producer Price Index (PPI) which is a measurement of the cost of producing goods. 

The Gross Domestic Product (GDP) measures the value of all goods and services within a country, while the M2 Money Supply measures the total amount of all currency. 

All in all, there are 28 major fundamental indicators used in the United States. 

Indicators have strong effects on financial markets so a FOREX trader should be aware of them when preparing currency market strategies. Up-to-date information is available on many websites and many FOREX brokers supply this information as part of their trading service. Whether or not a broker provides this information should be an important factor when you compare a FOREX broker with his or her peers.