Traders in the foreign exchange market implement the same two types of analysis as stock market investors do: fundamental and technical analysis. The applications of technical analysis in Forex are similar: the price is considered to reflect all news, and the charts are the focus of the study. But, unlike corporations, governments do not have balance sheets, so how can fundamental analysis be performed on a currency?
Because fundamental analysis examines the underlying worth of an investment, its application in Forex involves investigating the economic factors that influence the valuation of a country’s currency. Here, we look at some of the critical underlying components that influence currency movement.
What is fundamental analysis?
Fundamental analysis is a method for forecasting future asset prices according to outside events and facts. These occurrences and data are the core components of the economy. Fundamental factors include:
Economic indicators include:
- central bank interest rates
- GDP fluctuations
- deflation and inflation rates
- employment
- economic prospects
- political considerations
- market reports and rumors
- seasonality
- industry correlation
- economic expansion, cycles, and regularities.
Identifying as many important aspects as possible to predict commodity prices today is the main goal of fundamental analysis.
Types of Fundamental Analysis
When employing fundamental analysis, you can choose to focus on a small number of factors influencing an asset’s price or go far broader. It mostly depends on your knowledge, the amount of time you can devote to study, and the size of your transaction. Generally, traders seek correlations between instruments.
Top-down analysis
A top-down analytical strategy for fundamentals trading entails first researching macroeconomic aspects and determining how events may affect any asset you are interested in.
Bottom-up analysis
This form of study begins with an examination of the instrument and progresses upwards to see how it is influenced by the overall economic climate.
Balance of trade and interest rates
These variables are major currency drivers. A trade surplus indicates that a country’s goods and services are in great demand, as well as its currency. As demand rises, so will the number of buyers in the financial market. In the same way, increased relative interest rates stimulate cash inflows, and it raises the value of a currency.
Forces influencing demand and supply
During the epidemic, numerous items were in low supply, causing their prices to rise drastically. The price of oil has risen sharply as the globe prepares to ‘ return to work’. Essentially, every big event that alters supply or demand will have an impact on pricing.
How to Use Fundamental Analysis in Forex Trading
In Forex trading, fundamental analysis is used to predict secular bull and bear markets. Technical analysts discuss trends, but the medium- and long-term fundamental view determines the source of such trends.
Fundamental analysis traders will position themselves based on where they sense a major trend. There might be some short-term variations within the trend (which can be exploited using technical analysis). However, in general, a currency will move in a certain direction based on an economy’s long-term outlook and interest rates.
How economists, analysts, and traders interpret economic data influences market movements. Longer term, it all comes down to the direction of travel. Is a central bank tightening or easing interest rates? However, fundamental analysis may also be used to trade short-term Forex movements.
The key to short-term trading is to have clear expectations. Day traders often turn to economic data for indications. How did the data compare to market expectations? Did it outperform the consensus forecast? News traders will assess how data announcements relate to market expectations. Better-than-expected news should boost the currency’s value; disappointing data tends to depreciate it.
Moves may just last a few minutes or trend for several hours; nonetheless, when spotted, they may offer large returns for agile traders. After the market has absorbed the news, it may prepare for the next data release on the economic calendar.
Challenges of Fundamental Analysis
Fundamental analysis for Forex trading comes with several difficulties for traders. It is noteworthy that proceeding from economic information, data revisions can impress even the most stable currency quotes, thus making it challenging to predict activity fluctuations.
Also, specific unsettled political events in world politics including instabilities in political systems could act as a barrier in determining the fluctuating currency rates which may hinder traders.
The Forex market depends much on the investors’ opinions and feelings because it is nearly impossible to determine and forecast their shifts in sentiment.
Fundamental analysis is to some extent challenging in terms of economic indicators comprehension and their mutual relationship, so it takes a lot of time for the analysis.
Overcoming these challenges calls for constantly monitoring an entity’s position and reacting to ever-fluctuating Forex markets.
Final Thoughts about Forex Fundamental Analysis
Interest rates, inflation, and GDP are the three most important economic indicators utilized in Forex’s fundamental analysis. They are unparalleled in terms of economic influence in comparison to other elements such as retail sales, capital flow, trading balance, bond prices, and a plethora of other macroeconomic and geopolitical variables. Furthermore, economic indicators are not only compared across time, but some are also correlated across disciplines and boundaries.
