Fundamental analysis is the study of statistical reports and economic indicators of countries to trade currencies more effectively. Changes in interest rates, employment reports, and the latest inflation figures, all fall under the purview of fundamental analysis, which forex traders must pay close attention to, because they can have a direct bearing on the value of a nation’s currency. Data used in forex fundamental analysis can be classified by the degree to which they affect the market:
- Short term factors – These include unexpected news, to which the markets usually react within a day. Such news and events can be used for fast speculative trades.
- Long term factors – These include data on the general state of economy, such as inflation, unemployment rate or dramatic changes in the benchmark interest rate. Their impact on the exchange rates can last for weeks, months or even years.
Given the importance of these indicators, it is necessary to closely follow economic calendars, and know beforehand when they are scheduled for release. The most powerful indicators that move forex market include:
- Interest rate
- ·Generally, if a country increases its interest rates, its currency will increase in value because investors will shift their assets to that country to gain higher returns.
- Gross Domestic Product
- ·GDP is the primary indicator of the strength of economic activity in a country, and is generally reported quarterly. A high GDP figure leads to expectations of higher interest rates, which is mostly positive for the given currency.
- ·A decreases in payroll employment is considered as a sign of weak economic activity, and could eventually lead to lower interest rates, which has a negative impact on the currency.
- Trade balance
- ·A country with a significant trade balance deficit is likely to have a weak currency as there will be continuous commercial sellings of its currency.
Traders, who rely on fundamental analysis to study markets, will typically create models to formulate a trading strategy. These models generally utilize a host of empirical data and try to forecast market behavior and estimate future currency levels. This information is then used to draw out specific trades that best exploit the situation. Forecasting models are as varied and numerous as the traders that create them. Two people can analyze the exact same data and come up with two completely different conclusions about how it will impact the market. Therefore is it important to understand what is more relevant to the current market and economic conditions, and not succumb to ‘paralysis by analysis.’