Fundamental Analysis in Forex
October 10th, 2009
In foreign currency trading, fundamental analysis is a way of gauging how currency prices might react to changes in the “fundamentals”. What are those fundamentals? There are many, but the most important, the “market movers”, include the following (not in order):
* Economic conditions in various countries
* Stability, or instability, of governments and political environments
* Interest rates in various countries
* Currency supply and demand
* Policies of various governments
* Historic currency performance
* Countries’ deficit or surplus in international trade
* Cost of producing goods — known as PPI
* Consumer price index — known as CPI
* Gross domestic product — known as GDP
Each country’s central bank oversees the economy, and the fundamentals that affect it. The factors are announced by the central banks regularly, sometimes monthly but often weekly, and the exact time of these announcements is known in advance. These factors are called “indicators”.
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It’s important to understand that there is always a certain expectation of these indicators before they are announced, and currency traders are positioned in the forex market accordingly. If the announcement shows the indicator to be much as expected, there will be little or no movement in the currency.
But if the indicator that is announced is different from what was expected, you’re more likely to see movement in currency prices. That’s what fundamental analysis is all about, and lots of forex traders use this information exclusively in their trading. (This is probably not wise, however, and a combination of fundamental and forex technical analysis is a better basis for forex trading.)
The most influential of the central banks are the U.S. FED, the European Union’s ECB, Japan’s BOJ and the U.K. BOE. As the saying goes, when they speak, people listen — and also trade!
As might be expected, U.S. indicators have the biggest impact on the forex market. Although the ECB indicators have less impact, they can make a difference when they are different from what the market expected. Two of the major economic drivers that affect the forex market are interest rates and inflation, so listen carefully when knowledgeable financial experts talk about them.
Measuring the relationships among the fundamentals is a difficult task, which makes fundamental analysis all the more complex. Much of the process depends on estimates based on historical experience. On the opposite side, assumptions are often made on the basis of what’s happening in world news, such as wars, inflation, major political changes, etc. But these assumptions often don’t come true, and the markets may lag behind a bit in making adjustments.
The forex market is, like life itself, subject to the law of supply and demand. If currency prices remain at the same level despite a decrease in demand, eventually the price will increase. If the supply increases while the demand stays constant, the price will eventually decrease.
In a nutshell, then, this is how forex fundamental analysis works.
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