Undoubtedly, most of the Forex traders use technical analysis to place their trades. However, more enlightened and successful traders are likely to increase their trading success rate by benefiting from the fundamental analysis.
This article is going to discuss almost everything about the fundamental analysis. So please keep reading to know how to conduct trades via fundamental trading and how to apply it for profitable trading experience.
Introduction to Fundamental Analysis
In the prediction of price movements and discovering the Forex trading opportunities perspective, you may find two leading approaches. The first one is performing the technical analysis, in which you predict the direction of the price depending upon the historical price data and statistics.
The second and last approach is fundamental analysis. As the name suggests, you take into account the economic fundamentals of the provided assets, sectors, or even economy to predict if they are being traded at a high or low price than its actual fair price currently while expecting that the information given will reflect the price.
In simple words, the target is to predict the undervalue, overvalue, or correctly priced value of the assets using the based on publicly available data.
We importantly advise you to consider the fact that factors like supply and demand influence the Forex industry. So, the fundamental approach is to understand the effect of these factors to earn profits.
Fundamental trading is a popular way to trade, although it is associated with buy-and-hold strategies rather than short-term trading. Surprisingly, Warren Buffet and Benjamin Graham, both are among the most famous investors, often base their investment decisions on fundamentals.
Also, stock traders construct their fundamental assessments based on valuing the company’s financial statements. So, they get an idea of whether to sell or buy their stocks.
One can also use the fundamental approach when performing the analysis of the currency markets.
As the financial statements of the companies traders are valuing can help in determining if the stocks are going above or falling lower than their fair prices, the economic indices (that assist in measuring the financial performance of countries) may help in finding whether currencies are overpriced or underpriced.
Also, they assist in predicting the direction the markets can move in after completing the publication or even in the longer run.
However, you will have to consider a few factors before beginning to understand the fundamental analysis. The first thing is that the most relevant economic indices affect the currency’s performance a lot more than others.
So this suggests that publications of a few indices and figures are more likely to have a more considerable influence in the markets in comparison to releases of other relevant events or information.
Additionally, the markets are on the go depending upon the expectations of the future. Hence, the standard and the expectancy of different experts on any economic figure or event will be relevant. It is the case before and after the events take place, or the information is released.
Therefore, traders who look forward to adopting the fundamental approach must pay attention to the figures and events along with the forecasts of analysts as the expectations also affect the market’s reaction in some way or the other.
Fundamental Case Study- the U.S. Dollar
Here we are taking the U.S. dollar as an example. So the U.S. Dollar is the official currency of the USA, which signals that the currency’s performance is supposed to be inherently linked with the state of the U.S. economy and its explanations.
Not just this, the price behavior of the U.S. dollar is highly vulnerable to the U.S. itself: Any event or data that is relevant to the other currency can drive the traders to the Dollar, being the leading competitor of some of the most significant currencies (For example, the Yen or the Euro) along with a remarkable haven asset.
Given indices and relevant figures, many are regularly published by the private organization and the United States government. Consumer Price Index (also known as CPI or the inflation rate), for example, is issued by the U.S. Department of Labor Statistics. It helps in estimating if the country is going through a time of deflation or inflation.
Without having any personal view of the traders that they might have in interpreting the meaning of the figures for the economy of the USA, a lowering CPI is often considered as a green signal by the markets and vice versa.
The market expectations for CPI even results in altering the currency’s performance. For this reason, it is reasonable to discover that the publication of a specific figure has been priced in by the markets beforehand.
It is the reason the markets often do not reach up to the expectations after an important announcement or event, as at times the events itself are entirely foreseeable and were acquired by the traders already. Additionally, sometimes the prediction results faulty that leads to an unpredicted reaction in the markets.
Let’s suppose that the Federal Reserve announced an unforeseeable rate cut that tends to drive investors to sell their assets denominated with the Dollar. So, this will lead to an evident downward pressure on the currency after the announcement. Or else, they might have considered the outcome already, which will not have any dramatic reaction.
Like the interest rate and the Consumer Price Index are significant factors of information for trading experts, there are many other events and economic indicators that are relevant to the performance of a specific currency. Regarding the U.S. dollar, the Non-Farm payrolls figure and other economic indicators also count in.
Few of these tend to signal the exact state of the economy, so is the case for the figures of unemployment and the Gross Domestic Product. Where other factors might rise or effect future expectations, the interest rate announcements come in as an example, along with other statements and announcements made by central bank officials or government.
All other currencies follow the same thing. The rising Euro-Zone Consumer Price Index is likely to harm the performance of the Euro. Conversely, the positive assessment of the eurozone economy by the president of the European Central Bank might result positively.
The Forex Economic Calendar
Although in currency trading, it’s challenging to keep track of all the relevant data regarding a given currency, there is a need for it in the market. People can get this pertinent information from different news outlets, but it is better to have them through automatic updates. You can gain access to them through numerous Forex brokerages and news websites.
In a regular economic calendar, you do not only find real-time information of the most well-known currencies, but also information regarding upcoming happenings that may influence the market. These events include previous figures, the analyst’s expectations, and the chances of the effect of the reported information.
Many traders customize their economic calendars to what information they want to see and are relevant to them. For instance, a trader only wants to know the updates regarding the EUR/JPY pair. Now he/she will filter the economic calendar to receive information related to this specific pair that is the Japanese Yen and the Euro.
With the help of the economic calendar, the investors can identify and decide if the currency they have chosen has weak or strong fundamentals. In turn, this information will guide them on the decision to hold, buying, or selling the currency.
Another way to make use of the economic calendar and depend upon your fundamental assessments is by grounding your strategies on the notion of any third party.
Also, you can conduct personally conducted fundamental assessments on a few trading platforms, new sites, and by some brokers. Therefore, understanding how to read the theoretical analysis in Forex and depending upon the insights is a feasible idea.
Building and Applying the Fundamental Analysis
First of all, list down all the currencies your Forex brokerage offers for trading. Now check the latest information on these currencies that may affect their response in the economic calendar. The two common examples of employed data for performing the fundamental analysis are the Interest Rate and the GDP (Gross Domestic Product).
Importantly you should monitor the exact figures as in the market consensus forecasts that you may find on regular economic calendars. The information can be used for analyzing and comparing the market trends.
Also, they tell if the actual figures and the expert forecasts were inline or not. This step is the last one and holds significant importance as the impact of economic data publication relies on the unpredictability of information by the markets.
So if the figure and the market consensus are in line, then the effect will comparatively lower than that point where the relevant information has already been priced in the currency markets.
For instance, BEA (U.S. Bureau of Economic Analysis) reports that the GDP of the U.S. has risen in the past quarter. So, this will be a sign of a bull market as there are strong fundamentals.
Although, if the figures are in line with the analyst’s forecasts, there are high chances the data has been price din the market already. Due to this, the publication of this information will affect the Dollar more negatively comparing to if the information flow was higher than the expectation.
It is thereby essential top notice that analysis would have a better effect if the historical data (available on typical economic calendars) is used. Provided that, the investors can make use of the historical data to find out whether the performance of the U.S. economy is towards the upwards trajectory, which is a sign of a rising economy.
It is better to accompany your analysis with the help of other relevant economic information. Inflation level along with the manufacturing PMI (Product Manufacturing Index), for example.
Let’s say that an increasing manufacturing PMI might back up the case for the ever-increasing U.S. economy while supporting its bullish position.
Similarly, a negative figure might result in weakening your assessment and might be a sign to think of your strategy once again.
Following this approach, you can categorize your currency into three groups:
- Currencies have strong fundamentals: this means that you must act bullish on this currency.
- Currencies have weak fundamentals: this means you must be bearish on this currency.
- Currencies that are a mixture: According to this, you must either ignore (at least for now). You may remain neutral on whether or not to trade the currency.
In the case that a currency has strong fundamentals in comparison to other currencies, the best option is to then sell the currency with weak fundamentals for the one having bullish fundamentals.
For instance, according to your analysis, you must be bearish on the Australian Dollar and bullish on the Japanese Yen, then you must sell AUD/JPY. Other than this, it is best to sell the pair.
Trading with Fundamentals: A Warning!
Fundamental trading can prove to become a compelling way to earn big profits in the markets, especially if you trade using strategies based on technical analysis.
However, you should remember that the markets will not always react the way you expect them to after releasing financial information, even if they seem to respond positively or negatively.
Like we have mentioned above, at times, the markets price the event or decide to interpret data in some way before time. High unemployment statistics could be construed as a clear sign of the immobility of the employment market.
Even some other negative pieces of information, lower average earnings, for example, could be released at the same time and might grab the attention of the market.
FAQs:
How to conduct a fundamental analysis in Forex?
Well, the best way to perform the fundamental forex analysis is by having an economic calendar that covers all of the related information of the currencies that you are trading on Forex. Make sure to give special attention to high impact events.
How can I read a fundamental analysis?
Observe the changes in a country’s economic variables of their currency, like the rate of interest, inflation (CPI), and GDP. Now compare the data with the latest numbers and to the forecasts. If you monitor that the information is getting better with time and is beating the estimates, then according to the analysis, the currency will get powerful.
What is the fundamentals Analysis in Forex?
Fundamental analysis in Forex implies identifying the underlying value of a currency. Different economic indicators can help you in doing the following, the job market indicators, the Gross Domestic Product, and many more.
What is technical and fundamental analysis in Forex?
In technical analysis, you predict the price movements of a specific currency using the historical data and statistical trends.
Similarly, you predict the price movements here too, but with the help of the fundamentals of the given currency.
