Fundamental analysis is the in-depth study of geopolitical and economic events and various other forces that can impact the global financial markets.
This can encompass a wide range of things, including news releases, central bank policy changes, natural disasters and wars, company earnings, economic literature, and even socio-cultural movements.
There are different methodologies to do this, depending on the characteristics of an industry.
Fundamental Analysis in the Forex Markets
The currency performance of any country is dependent on the economic, political, and social stability in the region.
If these factors look strong enough for the near future, the currency value remains strong too.
A strong economy can attract ample foreign investments, which can further strengthen the value of the currency since these investors are required to make purchases and sales in the local currency.
It all comes down to the supply and demand balance; a currency in demand will surge in value and vice versa. For forex traders, it is important to stay abreast of certain indicators that can affect forex prices, such as:
1. Gross Domestic Product (GDP)
The GDP can be said to be a measure of the overall state of a country’s economy. It is the sum total of the monetary value of all goods and services produced over a specific period of time. Growth in the GDP is a good sign for the domestic currency, but it is not the sole driver. There are other factors to consider.
2. Interest Rate Policy
The central bank of a country is responsible for regulating monetary policies, which includes inflation and interest rates. Higher interest rates make the domestic currency more valuable.
The Consumer Price Index or CPI is an indicator of inflation growth of an economy. Together with the Producer Price Index (PPI), CPI data can serve another purpose – to give an idea of the future stance of the central bank regarding policies. Central banks release press briefings and minutes of meetings periodically, which traders can use to their advantage.
3. Trade Balance
Current account deficits and surpluses affect currency prices too. When exports are greater than imports, it reflects positively on the exchange rate. It also increases the overall health of the manufacturing sector, which is good for the GDP.
4. Employment Index
Indicators like the unemployment rate, the number of jobs created and hourly wages are important for traders since they offer an understanding of a country’s economic strength.
They also shed a light on the success or failure of government policies. This is especially important in the event of any elections in the near future. Non-farm payroll reports give a good understanding of this too.
Other factors to consider include the retail sales index, real-estate data, and any significant developments in the relations of a country with other neighboring states.
Today, electronic trading terminals have made it easier for traders to get the latest news and market developments as soon as they occur. But fundamental analysis is not just restricted to trade terminals, news reports, and trade journals. Using the right technical analysis tools to trade the resulting price fluctuations is essential for success too.