Introduction to Fundamental Analysis
The FOREX trader who really wants to profit trading foreign currencies should rely on more than just one type of analysis as they plan their trading strategies. Most traders will tell you that there are actually two basic types of FOREX analysis to choose from:
- Technical Analysis, and
- Fundamental Analysis.
Fundamental Analysis is the term which refers to analyzing and evaluating the unending flow of political, and economic, conditions that could conceivably affect currency prices. FOREX traders using fundamental analysis will primarily look at news reports from around the world in order to gather information about such topics as; unemployment rates, economic policies, inflation, geo-politics, and growth rates, and other relevant factors.
In FOREX trading, fundamental analysis, which is also used by traders in many other markets, is a means of getting an overview of worldwide currency movements and events, and to provide the FOREX trader with 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 then supplement and refine their findings by means of fundamental analysis.
Currency prices on the FOREX commonly react to the basic economic forces of supply and demand, which in turn are affected by economic conditions. Two of the 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 the trade balance.
Various indicators are periodically made available by both governmental and academic sources.
These indicators are reasonably reliable measures of economic health, and are closely watched by all investors, not just FOREX traders. Most indicators are usually released on a monthly basis but some are released weekly.
Two of the most important fundamental indicators are interest rates and international trade.
- 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, in turn, will usually strengthen the local currency.
On the other hand, stock market investors will often react to interest rate increases by selling off their holdings in the belief that higher costs of obtaining credit, essential to many businesses, will adversely affect the local economy. When stock investors sell off their holdings, this may trigger a downturn in the stock market, and the national economy.
Determining which of these two effects will predominate in a given situation will depend on a blend of several 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 (that is, there are more imports than exports) is usually going to be an unfavourable indicator for the FOREX trader. This is because a deficit trade balance means that money is flowing out of the country, as it is used to purchase foreign-made goods and will probably 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.
Thus, as a rule of thumb, trade deficits will only affect currency prices when they are beyond any range of normal market expectations.
Other indicators include the Gross Domestic Product (GDF), Consumer Price Index (CPI), Durable Goods Orders, Producer Price Index (PPI), Purchasing Manager's Index (PMI), and retail sales.
The Gross Domestic Product is a measure of 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, you will find that there are over 25 major indicators regularly used in fundamental analysis in the United States.
These indicators have strong effects on financial markets, so any FOREX trader should be aware of them when preparing currency market strategies. Up-to-date information is available on many websites, and a good FOREX broker will usually supply this kind of data 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.