FOREX traders almost always rely on
analysis to make plan their trading strategies. There are two basic types of
FOREX analysis – technical and fundamental. This section will look at
fundamental analysis and how it used in FOREX trading.
Fundamental analysis refers to
political and economic conditions that may affect currency prices. FOREX traders
using fundamental analysis rely on news reports to gather information about
unemployment rates, economic policies, inflation, and growth rates.
Fundamental analysis is often used to
get an overview of currency movements and to provide a broad picture of economic
conditions affecting a specific currency. Most traders rely on technical
analysis for plotting entry and exit points into the market and supplement their
findings with fundamental analysis.
Currency prices on the FOREX are
affected by the forces of supply and demand, which in turn are affected by
economic conditions. The two most important economic factors affecting supply
and demand are interest rates and the strength of the economy. The strength of
the economy is affected by the Gross Domestic Product (GDP), foreign investment
and trade balance.
Indicators
Various indicators are released by
government and academic sources. They are reliable measures of economic health
and are followed by all sectors of the investment market. Indicators are usually
released on a monthly basis but some are released weekly.
Two of the most important fundamental
indicators are interest rates and international trade. Other indicators include
the Consumer Price Index (CPI), Durable Goods Orders, Producer Price Index (PPI),
Purchasing Manager's Index (PMI), and retail sales.
Interest Rates
- can have either a
strengthening or weakening effect on a particular currency. High interest rates
attract foreign investment which will strengthen the local currency. On the
other hand, stock market investors often react to interest rate increases by
selling off their holdings in the belief that higher borrowing costs will
adversely affect many companies.
Stock investors may sell off their
holdings causing a downturn in the stock market and the national economy.
Determining which of these two effects will predominate depends on many complex
factors, but there is usually a consensus amongst economic observers of how
particular interest rate changes will affect the economy and the price of a
currency.
International Trade
– Trade balance
which shows a deficit (more imports than exports) is usually an unfavourable
indicator. Deficit trade balances means that money is flowing out of the country
to purchase foreign-made goods and this may have a devaluing effect on the
currency. Usually, market expectations dictate whether a deficit trade balance
is unfavourable or not. If a county habitually operates with a deficit trade
balance this has already been factored into the price of its currency. Trade
deficits will only affect currency prices when they are more than market
expectations.
Other indicators include the CPI
– a measurement of
the cost of living, and the PPI – a measurement of the cost of producing goods.
The GDP measures the value of all goods and services within a country, while the
M2 Money Supply measures the total amount of all currency.
There are 28 major indicators used in
the United States. Indicators have strong effects on financial markets so FOREX
traders should be aware of them when preparing strategies. Up-to-date
information is available on many websites and many FOREX brokers supply this
information as part of their trading service.
