Forex traders almost always rely on analysis to make plan their
trading strategies. There are two basic types of Forex analysis —
technical and fundamental. This article will look at fundamental
analysis and how it used in Forex trading.
Fundamental analysis refers to political and economic
conditions that may affect currency prices. Forex traders using
fundamental analysis rely on news reports to gather information about
unemployment rates, economic policies, inflation, and growth rates.
Fundamental analysis is often used to get an overview of
currency movements and to provide a broad picture of economic
conditions affecting a specific currency. Most traders 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 affected by the 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.
Various indicators are released by government and academic
sources. They are reliable measures of economic health and are followed
by all sectors of the investment market. 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. 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 — can have either a strengthening or weakening
effect on a particular currency. On the 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. Stock investors
may sell off their holdings causing a downturn in the stock market and
the national economy.
Determining which of these two effects will predominate
depends on many complex factors, but there is usually a consensus
amongst economic observers of how particular interest rate changes will
affect the economy and the price of a currency.
International Trade — Trade balance which shows a deficit
(more imports than exports) is usually an unfavourable indicator.
Deficit trade balances 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 more than market expectations.
Other indicators include the CPI — a measurement of the cost
of living, and the PPI — a measurement of the cost of producing goods.
The GDP measures the value of all goods and services within a country,
while the M2 Money Supply measures the total amount of all currency.
There are 28 major indicators used in the United States.
Indicators have strong effects on financial markets so Forex traders
should be aware of them when preparing strategies. Up-to-date
information is available on many websites and many Forex brokers supply
this information as part of their trading service.