nearly all Forex traders rely on a mix of fundamental analysis and technical analysis to make their trading decisions and this short article provides an introduction to the world of fundamental analysis.
It is often held that information is the basis of successful Forex trading but, while correct and timely information is indeed crucial for foreign currency trading, it is the analysis of this information that is the real secret. There are currently two main types of analysis which are used in foreign currency trading – fundamental and technical analysis - and here we look at exactly what is meant by fundamental analysis.
At its simplest, fundamental analysis examines political and economic conditions that could have an affect upon foreign currency prices and Forex traders who use fundamental analysis rely upon news reports for information about a range of things including, growth rates, inflation, economic policy and employment rates.
Basically, fundamental analysis gives an outline of currency movements and a broad picture of economic conditions which might well alter the value of a specific currency. With this picture in mind, foreign currency traders will then frequently move on to use technical analysis to then plot entry and exit points in the market and to extend the information gained through 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 themselves affected by economic conditions. Two of the most important economic factors affecting supply and demand are interest rates and the strength of the economy and the strength of the economy is affected by foreign investment, the gross domestic product (GDP) and the economy's balance of trade.
Various economic indicators are released by governments and by other sources and are generally considered to be reliable measures of the health of an economy that are followed by all sectors of the investment market. The majority of economic indicators are released once a month although some are published more frequently and generally weekly.
Two of the key fundamental indicators are international trade figures and interest rates, but other especially useful indicators include the, durable goods orders, consumer price index (CPI), purchasing manager's index (PMI), producer price index (PPI) and retail sales.
Interest rates are a particularly important indictor because they can have a strengthening or weakening affect on a particular currency. High interest rates may, for instance, attract foreign investment and strengthen the local currency, while stock market investors often react to rising interest rates by selling in the belief that higher borrowing costs will have an adverse affect on many companies. Large-scale selling by stock investors can often cause a downturn in the stock market and the national economy.
Indicators of international trade are also extremely important to the foreign currency trader. A shortfall on the trade balance, indicating that imports have exceeded exports, is generally seen to be an unfavorable indicator as money flowing out of the country to purchase 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 generally determine whether a trade deficit is unfavorable. For instance, it may be the case that a particular county frequently operates with a trade deficit and that this has already been taken into consideration in fixing the price of its currency. In general, trade deficits will only affect currency prices in cases where they are above the level that the market would normally expect to see.
Every country will have its own particular set of economic indicators (there are presently in the region of twenty-eight major indicators used in the US) and these have a strong influence on financial markets. As a result, Forex traders must be aware of them and examine them carefully when they are preparing their trading strategies.
Fortunately, for traders working online, many websites today provide a wealth of the latest information, but it is the responsibility of individual Forex traders to extract this information and then apply fundamental analysis to it before making their trading decisions.
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