As a forex trader, you will need to know about fundamental analysis.
One of the most important first steps as a beginner is education and research. You wouldn’t be foolish enough to jump into the deep end of the swimming pool without first learning to swim, and forex trading is no different.
The success you experience with trading starts with you.
Your desire, and need, to educate and familiarise yourself with this new complicated world of forex can be make or break.
We will cover here at a key topic that all new traders need to be aware of. A beginner’s look at forex fundamental analysis
Getting the basics right with forex market analysis, fundamental and technical
When starting your forex journey, you will need to get a grasp of what you are looking at, and how to interpret it. This is called analysis.
Forex market analysis usually falls into two main camps which we delve into below. These are forex fundamental analysis, and technical analysis.
Technical analysis is a vital part of trading and is concerned with the technical details. Technical analysis concerns looking at pricing data, charts and potential entry and exit points based on collected data. This data is often presented to you on charting software that includes different types of trading chart overlays and indicators. You can think of your technical analysis as the ‘specifics’.
Fundamental analysis differs from technical analysis as it does not focus on the technical raw data to draw conclusions. Fundamental analysis looks at the macroeconomics of a market, and focuses on external factors that could impact forex prices and cause fluctuations. Whilst there is detail in the topics, fundamental analysis is a lot more broad in scope.
Which type of analysis is more important in forex trading?
If you focus either on technical analysis, or fundamental analysis only, this will not give you the best results. If you were to base all your trades on technical analysis, you could well be ignoring an important external event that may cause a fluctuation in the wrong direction. This will cause a loss in the process.
We can apply technical analysis and fundamental analysis to more mainstream life scenarios and see the logic and fruitfulness behind using a combination.
Let’s take a look at the example of buying a house. This most certainly is not a decision taken lightly, and would be a topic that involves a lot of research.
You would look at similar properties, check out different locations, and external factors that may add value, like it being close to a school, good transport links and the average performance of house prices in the country. This would help you understand and see how external factors can affect the prices and would be your house buying version of forex fundamental analysis.
The technical analysis aspect of a house purchase could include how many bedrooms it has, what is the energy efficiency, what the average sale price of properties in the same street have been over the past few years, how many square meters it has, and the average price per m2 for property in this location.
Both of these sets of information, I’m sure you would agree are vital ingredients in a house purchase. Together, they would give a much more rounded evaluation of suitability than using one set of information exclusively.
Fundamental Analysis in Forex
Moving back to forex, technical analysis and fundamental analysis play equally important roles in helping you trade and profit.
Fundamental analysis with forex starts with the news. Keeping up with socioeconomic events is vital to your fundamental analysis research.
For example, if you are trading in CHF and there has been an announcement that there will be a decoupling with EUR, coming completely unexpectedly.
This actually happened in 2015, and had a huge impact on the trading value of the currency with CHF rising by more than 23% overnight. This caused massive fluctuations that could not be predicted by technical indicators and those receiving the news first would have had the maximum opportunity. There were countless traders, and brokers alike caught out by this event, and sent shockwaves through the forex markets in general.
If you look only at pricing patterns and disregard all the external factors, you may miss out on a huge opportunity.
A chart alone cannot account for these outside factors.
What are the main things to look for in forex analysis?
Forex traders will look at GDP of a country, inflation, unemployment rates, and political situation, amongst others.
Each of these factors could have a direct impact on the value of a currency, which can in turn, affect your profitability.
Gross Domestic Product (GDP)
This is the measure of the total value of goods and services produced in a country over a specific time period, usually 1 year.
It is particularly useful for a forex trader to analyse an economies’ GDP to see how well it is performing and to spot trends.
You will also want to consider looking at the GDP breakdown by business sector to look a little further into these trends and to see where an economy is headed longer term. It is typical that the more mature economies will have larger services income, and the more developing economies will have more in manufacturing. Knowing where an economy is heading and how it is maturing will give you a more detailed picture of where it is vulnerable.
If an economy is growing and performing well, companies will usually generate higher profits, meaning potentially higher wages.
All these combined result in a more valuable economy, and this would mean theoretically a higher currency value, provided the growth is outstripping that of others’.
Normally represented as a percentage, inflation is the rate at which the level of consumer goods and services are rising.
Inflation is a key indicator that is usually ‘managed’ by the central bank of each country. It is not controlled, but ‘managed’ only in that they will have a target range of acceptable inflation. Any indication of fluctuation outside of this acceptable range could cause them to intervene.
The Central Banks will at various stages, make interventions by adjusting interest rates for one thing. This is done to stabilise the economy and to ensure that the country does not enter periods of deflation, or at the other end of the scale, hyperinflation.
Forex traders would keep a close eye on a country’s inflation as it is likely that when if the numbers get outside of the usual target range of an economy, they could intervene.
Intervention by way of interest rate changes has a material and direct impact on the currency value.
The rate of unemployment would also be a good figure to keep an eye on as it is a good signal of overall economic health.
A strong trend of reducing unemployment statistics would indicate that more jobs are being created. When more jobs are being created, this is as a direct result of businesses needing additional resources, usually to cater for growth.
A healthy economy and a reducing unemployment also brings a more wealthier population, providing the right kind of jobs are being created. In this positive scenario, a strengthening economy would be a good sign in relation to the currency in use in that particular country.
The flip side of the above is also true, in inverse.
We can see from the mass activity of governments globally during the Covid-19 pandemic being mainly focused around job preservation and assisting businesses to retain employees.
Without this intervention, unemployment figures could have risen to catastrophic numbers and destabilised currencies in impacted regions.