What You Need To Know About Fundamental Analysis
You will probably be aware that you need to learn some technical analysis tools to get ahead in trading, and make the most of instant forex funding. Understanding how to interpret line charts, bar charts, and candlestick charts can help you to monitor the rhythm of price action for your currency pairs.
Technical analysis skills can lead to more informed and less risky trading decisions. However, some traders pay much more attention to fundamental analysis to guide their trading decisions. This involves using the economic data releases and wider current affairs to make predictions and look for patterns, rather than analysing charts and graphs.
Even if this is not the strategy you want to use for your core trading decisions, it’s still useful to have a basic understanding of how these factors influence the forex markets. Some traders find that paying equal attention to technical and fundamental analysis works well for them. Here is an overview of why traders use it to inform their actions.
What is fundamental analysis?
Fundamental analysis looks at the factors that influence the supply and demand of currencies and commodities, and consequently, the currency prices and exchange rates. This involves keeping up to date with current affairs, with an eye on political, economic and social changes and developments.
That all sounds like fairly basic stuff, you might be thinking. It is easy to keep up with the GDP and so on for your chosen currency nations. A politically stable nation that is doing well economically will have higher currency values than one with weak leadership and a flagging economy, which seems fairly obvious.
However, the complexity lies in the sheer amount of data that is available, and understanding what is relevant, and its probable effect on the markets. Here’s a look at what forex traders keep a beady eye on.
Economic data releases
Governments and private organisations will release data which gives an indicator of the country’s economic performance. These are released to a schedule, and there is data relevant to most of the world’s major economies released on a daily basis. In fact, it’s pretty much impossible to keep on top of all of it.
This is why forex traders will often keep track of them with an economic calendar, which are freely available to download from financial websites. Some economic factors are very well known to affect the currency value, such as the interest rates and the inflation rates. Others are less known, such as the durable goods orders.
Some of the data is based on hard sales figures, and some of it is based on surveys and opinion polls. The data can be interpreted to show how well the economy has performed over a past period of time, how well it is doing currently, or to predict how it might perform in the future.
The data that is of the greatest interest to traders is that which will indicate how an economy might develop in the future. The data should then be further filtered into that which will have a low impact on the forex markets, and that which will influence price action. Here’s a look at the most important indicators.
Gross Domestic Product (GDP)
GDP is the most general economic weathervane of a country. It is the total market value of all the goods and services produced over a year, and it can confirm whether or not a country is in recession. Although much of the data is historical, two consecutive quarters which show a contraction of GDP are the official definition of a recession.
The unemployment rate is related to GDP, as it is a good indicator of the economic health of a country. It includes figures for the percentage of a population who are actively seeking paid work, rather than those who are economically unactive and not seeking work. This is especially relevant in the US, because the dollar is the most widely used currency pair.
If the data is worse or better than expected, this can impact the forex markets. It’s tied to how much demand there is likely to be for goods and services, and how confident businesses and consumers are about spending and investment decisions.
Consumer Price Index (CPI)
The CPI is a measure of the price of consumer goods and services. Representative samples from over 200 categories are used to compile a report which shows the cost of various goods at the moment of publication. Forex traders should narrow down the focus to the cost of exports, because this is the most relevant to the exchange rates.
If your trading pairs include the US dollar, which the majority of currency pairs do, then you should pay particular attention to the US specific releases. These include Nonfarm Payrolls, the Federal Funds rate, the University of Michigan Index of Consumer Sentiment, and the Industrial Production Index.
The Central Banks
In the UK, the Central Bank is the Bank of England (BoE). It has the power to raise or lower interest rates, which can influence the inflation rate. In the US, the central bank is known as the Federal Reserve. Higher interest rates in the US will make the dollar more powerful, and lower demand for other currencies.
They can also introduce economic policies, such as quantitative easing, which will strongly impact the nations’ economy. Therefore, it’s important to follow all the statements and comments made by central bank representatives.
The world is in a particularly turbulent phase at the moment, with the Russian invasion of Ukraine still sending shockwaves around the world, the effects of the pandemic still reverberating in the economy and the wider population, and the ongoing conflicts in the Middle East.
The effect of the war in Europe can be seen at the moment, with a strain on oil and gas supplies, and certain food products. Geopolitical events don’t have to be on such a big and dramatic scale, however. They can be local election results, changes in government policy, scientific developments or discoveries, and many other factors.
Natural disasters will also have a significant impact on the economy and therefore value of a currency. This could be through lost labour hours, decreased productivity, the cost of repairs and rescue operations, disruption to transport and supply chains, destruction of goods and service centres, increased sickness rates, and a whole host of other factors.
As we see the more extreme effects of climate change every year, once relatively rare events, such as hurricanes, wildfires, floods, and water shortages, occur around the world on a regular basis. Therefore, forex traders who employ fundamental analysis techniques will keep an eye on the news for climate related events.
Even less dramatic weather events, such as a colder summer than usual, can drive changes in the demand for consumer goods and energy prices. For example, predicted sales of barbecues and beachwear may be below par, while energy use goes up, and unseasonable goods, such as waterproof clothing, experience unexpectedly high sales.
The key takeaway is that unexpected, or even predictable changes, can cause turbulence in the markets. This can open up opportunities for a trader to maximise profits, or adjust stop loss margins.
Seasonality in forex trading
Some seasonal factors can be used to predict the way the forex markets will react. These include national holidays, especially those in countries with major economies. Christmas, Thanksgiving, Independence Day, Halloween, Easter, and so on will all have an impact on the demand for certain goods and services.
Seasonality refers to both calendar events and climatic conditions. For example, during the summer, many people go on vacation, causing increased demand for fuel and foreign travel. If the weather is warm, air-conditioning units and garden furniture sales may go up, and poorer than usual weather may impact on the tourism and hospitality industry.
The weather can also influence harvests and therefore food production, which in turn affects export and imports rates, and ultimately the balance of trade between nations. Therefore, it’s important to know which are the major commodity exports and imports of the countries whose currencies you trade with.
Some seasonal factors are cyclical, and predictable, such as fixed calendar holidays, which can drive demand for certain goods and services. This allows traders to identify patterns which helps them to predict the best times to make profitable trades for their chosen currency pairs.
Different currencies tend to ebb and flow according to the time of year, but there is not always an easily identifiable explanation as to why this is. September is generally the most volatile month on the forex markets, with lows occurring in February and August.
How do traders use fundamental analysis in their strategies?
By looking for the probable future direction of the markets, forex traders identify a key price level that they expect the price to break through, and use this as a guide to buy or sell for maximum profit. To learn how to make the most of this strategy, traders should make sure that they understand support and resistance levels.