Basics of Fundamental Analysis in Forex Trading

Fundamental analysis takes into account economic, social and political variables that affect supply and demand of assets. Basically, supply and demand affect price and like everywhere else in the world, this counts also for the Forex. Based on various factors we can get an idea of how the country thrives. If the economy a particular country is doing well, its currency strengthens. Investors will want to invest in the country which means that they will have to buy a given menu. This means that if the economy is good, currency value rises. If it is bad, so the value of currency decreases.

What is Fundamental analysis
In general fundamental analysis tries to predict how the economic, social and political variables affect exchange rate movements (stocks, commodities or currencies). Default forecasting procedure consists from three steps:

  • Global Analysis – examines the overall economic situation
  • Field Analysis – examines trends in the development of the field
  • Analysis of specific entities – examines the value of stocks, commodities or value of the currency

We can divide the basic needs for fundamental analysis on Forex market into two steps:

  • Global Analysis – analysis forecasting development of currency markets in total
  • Analysis of specific entities – specifically at Forex market follows the development of a currency pair

But because of the Forex market being an internationally interlinked market, almost without borders and limitations, these two steps often blend together creating one big fundamental analysis of the global Forex market.

Fundamental analysis is a way to look at the market through the economic, social and political aspects that influence supply and demand of assets. In other words we are looking for an economy that is doing as well and regularly as its currency is doing. The better the country’s economy is doing, the more the neighboring countries believe in its currency. Marketers use the information based on the reviews posted on financial magazines, websites or published in professional journals and financial newspapers periodically weekly or monthly, in addition to the GDP (Gross Domestic Product) and ECI (Employment Cost Index), which are issued quarterly.

The most important information sources include financial newspaper such as Wall Street Journal, Financial Times, The New York Times, Business Week magazine, for example: as well as websites such as Reuters or Bloomberg, being these two the most prominent.

There are loads of fundamentals and other factors that cause changes in the rates of currency pairs; and fundamental analysis is extremely important for the trader. Even a trader who trades only on the basis of technical analysis must take into account the announced reports.

Politics moves with Forex
All the changes in the movements of currency pairs are directly tied to changes in government, military, economic or financial policy of superpowers. Political crises are usually very dangerous and mostly unpredictable for the markets. Contrary to anticipated political events (elections, conclusions of interstate agreements, etc.), which generally take place at the exactly specified time and provide the market with opportunities coming from these changes, political crises come all of a sudden. It is important to know that in cases such as political crises, the spread can expand from 5 to 100 pips. Then you need to act quickly and with a cool head to avoid large losses.

If you are considering and deciding to trade according to fundamental news, be aware that markets do not always react as they are expected to. Nervousness and speculation about possible developments even before the important messages are announced, often excite false signals to enter the trade. Therefore, it is important and necessary to carefully test the method of inputs and outputs, preferably on some demo platform with actual and real data.

There are a lot of factors that can cause a nation’s currency to fluctuate. The key concept is that the movement of currencies is based on supply and demand, which is influenced by both economic factors and confidence factors.

Basic indicators of Fundamental Analysis
Fundamental analysis aims to determine a currency’s value by assessing the relative strength and weakness of a country’s economy compared to those of its trading partners. GDP growth, inflation, interest rates, and political stability and other factors are all taken into account.

Interest Rates
Growth in interest rates causes an increase of nominal value of bonds and interest rate bonds. Interest rates are charged by various financial institutions. For example, the Prime Rate is an interest rate charged by banks to reputable customers and the Federal Funds Rate is an inter-bank rate for borrowing reserves to meet margin requirements. If there is an uncertainty in the market in terms of interest rates, any developments regarding interest rates could have a direct affect on the currency markets. Generally, when a country raises its interest rates, the country’s currency will strengthen in relation to other currencies as assets are shifted to gain a higher return. The timing at which the interest rate moves is usually known in advance. Interest rates are announced by central banks of individual countries, and the most important are:

  • Bank of England
  • United States Federal Reserve
  • European Central Bank
  • Swiss National Bank
  • Bank of Japan
  • Reserve Bank of Australia
  • Reserve Bank of New Zealand

Economic Indicators

  • GNP (Gross National Product) – GNP refers to the sum of all goods and services created by citizens of specific country.
  • GDP (Gross Domestic Product) – GDP indicates the value of all products and services produced in the country regardless of who owns the assets, or what nationality is the labor used to produce such products and services. The Gross Domestic Product is then the sum of all goods and services produced by both domestic and foreign companies in the economy in a year. GDP is a good indicator for the pace at which a country’s economy is growing or shrinking as it measures the country’s economic output and growth.
  • Consumer spending
  • Investment spending
  • Government Spending

Indicators of Industrial Sector

  • Industrial Production – Industrial Production is the quarterly measure of the change in the amount of goods and services produced per unit of input. It incorporates labor and capital inputs.
  • Capacity Utilization
  • Factory Orders
  • Durable Goods Orders – Durable Goods Orders measure the new orders placed with domestic manufacturers for delivery of hard goods.
  • Business inventories – Business inventories and sales figures consist of data from other reports such as durable goods orders, factory orders, retail sales, and wholesale inventories and sales data. Inventories are an important component of the GDP report because they help distinguish which part of the total output produced (GOP) remains unsold.

Indicators of Construction Sector

  • Planning permissions
  • Registrations, a proxy for housing starts
  • Dwellings completed
  • Investment in construction industry

Indicators of Construction Sector

    • Fiscal Policy – is the part of a national economic policy that affects the economy changes related to the amount and structure of public spending and taxes.
    • Monetary Policy – is the part of a national economic policy implemented by the central bank’s monetary instruments.
    • Inflation – refers to the increase in prices (price level)and wages over time that decrease purchasing power. It is calculated from changes in the price index, usually a consumer price index, or a GDP deflator.
    • PPI (Producer price index) – The PPI measures the average changes in selling price as indicated by domestic producers for their output in various industries. The Forex market tends to focus on the PPI for seasonally adjusted finished goods on a monthly, quarterly, semiannual and annual basis. PPI is an accurate precursor of the important Consumer Prices Index (CPI) figure.
    • CPI (Consumer Price Index) – The CPI is a primary indicator of inflation that measures the average price for goods and services most commonly used by a typical household. By definition, it is a measure of the average price level paid by urban consumers for a fixed basket of goods and services. It reports price changes in over 200 categories. Items included in the CPI reflect prices of food, clothing, shelter, fuel, transportation, health care and all other goods and services that people buy for day-to-day living.
    • GNP deflator – current and constant proportion of GNP
    • GDP deflator – current and constant share of GDP
    • Commodity Research Bureau’s (CRB)
  • Merchandise Trade Balance – balance of trade in goods

Indicators of Construction Sector

  • Report of the Employment Status – generally the most important indicator.
  • ECI (Employment Cost Index ) – the index of wage costs.
  • Retail Sales
  • Vehicle Motor Sales – the index of sales of motor vehicles
  • Personal income

Main Indicators

  • Average workweek of production workers
  • Average weekly claims for state unemployment
  • New orders of consumer goods and materials
  • Performance sellers
  • Contracts and orders for factories and equipment
  • New building permits issued
  • Change of the orders in the backlog of manufacturers
  • Change in the prices of materials

Fundamental analysis is a very effective and efficient method to forecast economic conditions, but not necessarily exact at forecasting market price movements. It important to study the fundamentals and see how they best fit your trading style before casting yourself into a particular mold regarding any aspect of market analysis. Furthermore, it is vital to stay current with public announcements and news that can suddenly move an exchange rate hundreds of pips in a matter of minutes.

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