In order for a Forex trader to make profit from trading in the market, he must be able to predict the movements of the prices. To do this, he can resort to using “Fundamental Analysis” or “Technical Analysis” to help him formulate his prediction about the Forex price movements. Fundamental analysis looks at the macro economic factors that can affect a currency exchange rate such as news and economic events and indicators.
The focus of fundamental analysis mainly lies on the political, social, and economic force that drives the supply/demand trends the currency. Government policies, bank policies, natural disasters, social stability, overall economic trends are some of the major factors that draw a fundamentalist’s attention.
Fundamental analysis comes very handy in making mid-long term invesment decisions. However as the analysis method is mainly focus on the major thing, it will not be a good tool for Forex day traders.
It is easy to understand that fundamental skills are useful in forecasting currencies overall trends but in term of detailing job, technical analysis seems to be more appropriate.
Economic Indicators
Fundamental analysis involve a lot of analysis on the macroeconomic situation.
Thus, economy indicators of the country such as GDP growth rates, unemployment rates, retail sales, and interest rate are used heavily in when valuating a country's currency. Some of the frequent used economy indicators in Forex trading are as below :
Interest Rate:
In each country whose currency is traded in the Forex market, the Central Bank of the respective country will determine the overnight lending rate the commercial banks. The control of interest rate is essential for the central bank of a country to implement its monetary policies. Hence, the interest rate is used as a tool to expand or contract the money supply. Generally, a lower interest rate will cause a country’s currency to depreciate.
This is because of the Forex traders who indulge in carry trades. This is a trading strategy where a Forex trader sells a currency that is yielding low interest for another currency that is earning a higher interest rate. This is because currencies with higher interest rates will normally rise in value. In addition, with trading rollover, traders are also able to earn interest daily.
Unemployment Rate:
This is one of the primary indicators of how well a country’s economy is doing. Thus, high unemployment rate will indicate the country’s economy is performing poorly and this will lead to a depreciation of a country’s currency.
Geopolitical Scenario:
All significant global political events will affect the financial markets and not just the Forex market.
Using Fundamental Analysis:
The use of fundamental analysis is particularly useful in predicting the long term trend of a currency and its corresponding pair. By concentrating on those long term factors which affects a country economic growth, traders are able to generally predict which way a currency pair will move in the long term.
Examples of Fundamental Analysis Application in Trading Major Currencies:
EUR/USD
Typically, when the US dollar weakens, the Euro will rise in relation. Conversely, when the US dollar strengthens, Euro’s value will decline in relation. Thus, when the US economy faces increasing higher unemployment rate, this will result in the US dollar weakening. Therefore a trader will buy (Ask) the Euro with the expectation that it will appreciate against the US dollar.
Similarly, if there is a surge in demand for US financial instruments like treasury bonds or equities, this will help push the value of the US dollar up in relation to the Euro. In this case, a trader will want to sell (Bid) the Euro as the value of US dollar will appreciate.
USD/JPY
If the Japanese Government wishes to boost the demand for their exports, they will seek to try to weaken the Japanese yen in relation to the US dollar. When that happens, the USD/JPY will rise in its price. Traders wishing to benefit from this scenario should buy the USD/JPY (Ask) in anticipation of the increase in US dollar. Similarly, when the level of Foreign Direct Investment (FDI) increases in Japan, this will help push up the value of the yen in relation to the US dollar. If that is the case, traders should sell (Bid) the USD/JPY hoping to profit from the appreciation in the yen.
GBP/USD
If the money supply in the UK economy increases, this will result in the supply of money exceeding the demand of money. This will mean that the banks will have more money to lend resulting in lower interest rates as a result will depreciate the value of the British pound in relation to the US dollar. Hence, a trader will want to sell (Bid) the GBP/USD currency pair. Conversely, due to prudent monetary policies, the UK’s economy is enjoying robust growth as reflected in the increasing growth rate of its Gross Domestic Product (GDP). This will result in the value of the British pound appreciating in relation to the US dollar. Therefore, traders will want to buy (Ask) the GBP/USD currency pair.
USD/CHF
The Swiss franc is normally seen as a safe haven currency. Thus, during times of global instability, the Swiss franc becomes a highly demanded currency. Therefore, it will appreciate in value in relation to the USD. Therefore, traders should sell (Bid) the USD/CHF. On the other hand, during times of stability, the demand for the US dollar will increase as people will see less need for parking their money in Swiss franc as a safe haven currency. In this situation, traders will buy (Ask) the USD/CHF as the US dollar continue to strengthen against the Swiss franc.
EUR/CHF
In this scenario, high inflation rates in the European Union (EU) countries will drive down the value of EUR/CHF. Traders will respond by selling (Bid) the EUR/CHF currency pair. On the other hand, increasing GDP of the EU countries will show that the EU economies are healthy. This will drive up the value of the EUR/CHF. Hence, traders in this situation will react by buying (Ask) the EUR/CHF currency pair.
AUS/USD
One of the biggest export earners for Australia comes from the mining sector. Hence, any increase in commodities prices will boast the export earning of Australia. This will benefit the value of the Australian dollar. Here, traders will react by buying (Ask) the AUS/USD currency pair since the Australian dollar will strengthen against the US dollar. Another major export earner for Australia comes from the agricultural sector. Therefore, if Australia is facing widespread drought, this will cause the agricultural sector to decrease its contribution to export earning for the Australian economy. As a result, the Australian dollar will depreciate in relation to the US dollar. Therefore for traders to profit for this situation, they should, sell (Bid) the AUS/USD currency pair as the Australian dollar will slide in value against the US dollar.
USD/CAD
Continuing high unemployment rates suffered by the Canadian economy will result in the Canadian dollar depreciating against the US dollar. In order to take advantage of this scenario, traders should buy (Ask) the USD/CAD currency pair. On the contrary, if the Canadian economy is going to rebound due to lower unemployment rates, this will result in the Canadian dollar appreciating against the US dollar. For traders to profit for this, they should sell (Buy) the USD/CAD currency pair.
NZD/USD
New Zealand controls a third of the global trade in dairy and meat products. In essence, this country’s economy is centered on its agricultural sector. Therefore any factors that affect this sector of its export earnings will affect its exchange rate. As such, a decline in dairy output in the US as a result of natural disaster will result in increased demand for New Zealand dairy exports. This will definitely cause the New Zealand dollar to appreciate in value in relation to the US dollar. To benefit from this, traders should buy (Ask) the NZD/USD currency pair. On the other side of the coin if however due to widespread foot & mouth disease, this will cause a decline in dairy and meat production in New Zealand. The subsequent effect will be a decline in export earnings and hence a depreciating New Zealand dollar. To profit from this, traders ought to sell (Bid) the NZD/USD currency pair.
Besides those listed above, other fundamental factors used to analysis the currency strength include Industrial Production Reports, Consumer Price Index (CPI), Manufacturing PMI-ISM, and Manufacturing Production. We will cover each of these indicators from time to time.
How are indicators used in Forex fundamentals trading?
A country's economic situation refelects directly onto the currecny trading world. Hence, it is important for a Forex traders to keep an close eye on the financial clalender release by it country itself or private sectors. It is important to keep in mind, however, that the indicators discussed above are not the only things that affect a currency's price. There are third-party reports, technical factors, and many other things that also can drastically affect a currency's valuation.
Also, it is recommended to study the fundamental aspects of several country whenever trading in the forex market. For those countries that have strong political/economical connection, currencies value flux hand-in-hand. Thus researching a few countru in a trade is necessary.
Some useful tips when implementing fundamentals analysis in Forex trading are:*
* Economic calendar: When and where. Currency values response sharply to certain release of economic indicators. Keep an close eyes on the currency price trend whenver there is a release on related economy indicators.
* Be informed about the economic indicators that are capturing most of the market's attention at any given time. Such indicators are catalysts for the largest price and volume movements. For example, when the U.S. dollar is weak, inflation is often one of the most watched indicators.
* Know the market expectations for the data, and then pay attention to whether or not the expectations are met. That is far more important than the data itself. Occasionally, there is a drastic difference between the expectations and actual results and, if there is, be aware of the possible justifications for this difference.
*References from http://www.investopedia.com/articles/trading/04/031704.asp
From Fundamentals to Technicals in FX Market
Pure fundamental trading is very problematic. Without a doubt the analysis is very effective in predicting the overall economic condition and the market behavior.
It gives a clear picture on general economy health of certain entity (a country in case of Forex) and shows how economic situation became what it is now as well as predicting the overall economic growth trend in the future.
However, information obtained through fundamental studies often fail to signify short term fluctuation in Forex market. Thus, it is wise to apply precise techniques to convert fundamental study’s results into accurate entry/exit price indicators.
