Most FOREX traders rely on analysis to plan their trading strategy. Traders use two common forms of analysis, fundamental and technical. This article will specifically discuss fundamental analysis. After reading this article you should have a better understanding of fundamental analysis and how to use it as part of your Forex strategy.
Political and economic changes are the basis of fundamental analysis. These changes can frequently affect currency prices. Traders that utilise fundamental analysis will gather their information from a variety of news sources. They are looking for information about unemployment forecasts, political ideologies, economic policies, inflation and growth rates.
Fundamental analysis will provide you with an overview of currency movements and a broad picture of the economic conditions. Most traders combine fundamental analysis with technical analysis to plot actual entrance and exit points as well as confirming the information.
Supply and demand control the Forex market, as with other markets. Many economic factors can effect the supply and demand but the two most critical ones are interest rates and the strength of the economy. Changes in the GDP, trade balances and the amount of foreign investment affect the overall strength of the economy.
Government and academic sources release many economic indicators that are readily available to the public. These indicators are usually released on a monthly basis but will sometimes be released weekly. Traders closely follow these indicators as they are reliable measures of economic health. While there are many fundamental analysis indicators released, some of the most important are: interest rates, international trade, CPI (Consumer Price Index), durable goods orders, PPI (Producer Price Index), PMI (Purchasing Managers Index) and retail orders.
Interest Rates can cause a currency to either strengthen or weaken depending on the direction of movement. In some cases high interest rates will attract foreign money positively effecting the economy. Conversely high interest rates will frequently cause stock market investors to sell of their portfolios. They do this believing that the higher cost of borrowing money will adversely effect many companies. If enough investors sell of their holdings in can cause a downturn in the market and negatively affect the economy.
Which of these two effects will take place depends on many complex factors. There is usually agreement among economic observers as to how changes in interest rates will effect the general economy and the price of currency.
Trade deficits, more items imported than exported, are usually considered a negative indicator. When there is a trade deficit it means that more money is leaving the country to buy foreign goods than is entering. Fundamental analysis principles tell us that this can have a devaluing effect on the currency. Trade imbalances not already factored into the market consideration usually result in devaluation of currency. If a country normally operates with a trade deficit then there should not be an effect on the currency price. The currency price will normally only be effected by trade differences when the deficit is greater than expected.
The cost of living (CPI) and the cost of producing goods (PPI) are also important indicators in fundamental analysis. Traders should also watch the GDP which measures the value of all the goods produced in a country. Finally the M2 Money Supply which measures the total amount of currency for a country can also be useful.
In the US alone there are 28 major indicators. These indicators can have a strong effect on the financial market and should be closely watched. This information can be found many places on the internet and is provided by many brokers.
Read more about technical analysis in this article.