It is commonly held that the key to profitable Forex trading is information but, though accurate and timely information is indeed central to foreign currency trading, it is the examination of this information which is the true secret. There are two main forms of analysis which are used in foreign currency trading � fundamental and technical analysis – and here we examine precisely what is meant by fundamental analysis.
In its simplest form, fundamental analysis scrutinizes both political and economic conditions which might have an affect upon foreign currency prices and Forex traders who use fundamental analysis rely on news reports for information about a range of things including economic policy, growth rates, inflation and rates of unemployment.
Basically, fundamental analysis gives an outline of currency movements and a broad view of economic conditions that might well affect the value of a specific currency. With this view in mind, foreign currency traders will then often move on to use technical analysis to plot entry and exit points in the market and to augment the information gained using fundamental analysis.
The foreign currency market is much like any other market and is governed to a large degree by the laws of supply and demand, which are also affected by economic conditions. Two of the most important economic factors which affect supply and demand are the strength of the economy and interest rates and the strength of the economy is affected by the gross domestic product (GDP), foreign investment and the economy’s trade balance.
Many different economic indicators are released by governments and by other sources and are usually considered to be good measures of economic health which are followed by all sectors of the investment market. Nearly all economic indicators are released monthly although some are released more frequently and generally weekly.
Two of the principle fundamental indicators are international trade figures and interest rates, but other extremely useful indicators include the purchasing manager’s index (PMI), producer price index (PPI), durable goods orders, consumer price index (CPI) and retail sales.
Interest rates are an extremely important indictor because they can have either a strengthening or weakening affect on a particular currency. High interest rates may, for example, attract foreign investment and strengthen the local currency, while investors in the stock market generally react to rising interest rates by selling because of a belief that higher borrowing costs will have an adverse affect on many companies. High volume selling by stock investors can often result in a downturn in both the stock market and the economy.
International trade indicators are also especially important to the foreign currency trader. A trade deficit, with imports exceeding exports, is generally seen as an adverse indicator as money leaving the country to buy foreign goods may well have a devaluing affect on the currency. However, fundamental analysis will also point up the expectations of the market and these will frequently determine whether or not a trade deficit is unfavorable. For example, it might be the case that a particular county usually operates with a trade deficit and that this fact has already been factored into the price of its currency. In general terms, a trade deficit will only affect currency prices where they are higher than the market would usually expect to see.
Each country has its own particular set of economic indicators (there are presently some twenty-eight major indicators being used in the United States) and these have a strong influence on financial markets. For this reason, Forex traders have to be aware of them and examine them carefully when preparing their trading strategies.
Fortunately, for traders working on the Internet, many sites now carry an abundance of the latest information, but it is the responsibility of individual Forex traders to take this information and apply the principles of fundamental analysis to it in order to formulate their trading decisions.