Fundamental Analysis is the process of examining the economic, social and political factors that might affect the price and performance of a financial asset.
Fundamental Analysis in the Forex markets involves the analysis of these three forces in the form of economic events (such as an election or change in legislation), geopolitical events (like the building of a border wall or the way drought affects a population) and social factors (such as demands by a workers union). All three factors play a crucial role in the performance of a country’s currency in comparison to its peers.
Examples of key fundamental factors that affect currencies
There’s a huge number of factors that affect the performance of individual currencies and affect the strength or weakness of a country’s currency against another. Some of the major fundamental factors include:
The first step to performing Fundamental Analysis is to choose the currency pair you want to analyze. Most of the fundamental data you’ll need is provided by government agencies and, in most cases, you can access it easily online or be prepared for it by using economic calendars. Some of the key fundamental data commonly referred to by traders includes trade balance data, GDP data and employment data.
The ultimate goal of Fundamental Analysis is to determine the current state of a country’s economy and assess its future economic prospects. Some key questions to consider when performing Fundamental Analysis include:
1. Is the country’s economy growing?
Examining a country’s GDP growth over the last four quarters lets you see if there is a pattern of consistent expansion or contraction. Consistent expansion of a country’s GDP is an indicator that its economy is doing well, while declining GDP growth is a sign that the economy is underperforming.
2. How high are the Central Bank interest rates?
Depending on whether a country is classified as a developed or developing country, Central Bank interest rates will generally differ. For example, since the 2008 global economic recession most developed countries have had very low interest rates, while developing countries have largely maintained quite high interest rate levels. Interest rates levels are usually an indicator of the Central Bank’s confidence in a country’s economy. If rates have been rising, the economy is supposed to be doing well. If they’re declining, the opposite is true.
3. Are inflation levels rising?
A country’s inflation level, is a strong indicator of its citizens buying power, which reflects whether their economic position is considered strong or weak. Citizens with high purchasing power are usually doing better than citizens with low purchasing power. A good measure of inflation is the Consumer Price Index (CPI) data.
4. Is the country politically stable?
The political stability of a country can be assessed from its current political climate as well as its last election. Developing countries with peaceful elections are usually regarded as being more politically stable, as compared to those with elections mired in controversy and violence. Developed countries with stable political processes and strong judiciaries are regarded as being politically stable.
5. What is the country’s employment situation?
What is the country’s current unemployment rate in comparison to past data and is there earnings growth among its working population? Countries with low unemployment rates and substantial earnings growth usually have better performing economies, as opposed to countries with high unemployment rates and stagnant earnings. Employment and unemployment data is considered to be highly relevant to Fundamental Analysis, as is the jobless claims data.
When getting started applying Fundamental Analysis to your daily trading activities, one approach is to focus on assessing the economic releases planned for a given week. You can then begin to identify the releases that are likely to have a significant impact on a particular currency pair. An easy way to isolate such events is to use an economic calendar to see whether they have been classified as high impact releases.
You can use this information to plan your trades in line with the calendar and your expectations for whether the data meets analysts’ estimates. By analysing historical data you can begin to understand and predict a currency’s possible reaction to the economic releases, based on past performance. However, it’s worth remembering that your predictions may not be correct as the markets can move in any direction, so you should expect and plan for it in your trading strategy, which can be implemented through good practise risk-management.
You should also expect geopolitical events to affect currency pairs, but these are often difficult to anticipate and are best handled through proper risk management.
Fundamental Analysis can be an extremely valuable skill for Forex traders who want to capitalize on the short-term price movements generated by economic releases. However, it might take some time before you can fully master how to trade based on fundamental factors due to the inherent complexities of fundamental analysis. If you can learn how to incorporate fundamental analysis into your overall strategy while balancing it out with strong risk management techniques, you’ll be setting yourself up with a better chance of succeeding in the markets.
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