Introduction to Fundamental Analysis

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 article
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. On the one hand, 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, however, 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.