Your decisions to buy or sell should be based on properly conducted analysis. There are chiefly two ways of conducting this analysis to make trading decisions, namely Fundamental Analysis and Technical Analysis. Fundamental Analysis involves studying economic events, reports and other anxilliary factors in forecasting the potential direction of a currency pair, or any other asset. On the other hand, technical analysis involves the study of charts and use of mathematical indicators to arrive at guesses as to where the market may be headed. A third method of conducting analysis, sentiment analysis, is not so popular, and in some quarters, not considered as a form of analysis on its own.
This piece delves into the topic of Fundamental analysis, giving an overview of its major components.
Why Fundamental Analysis
Ideally, we should not be asking and answering the question, “why fundamental analysis?” The obvious answer should be “why not?” However, due to the overshadowing popularity of technical analysis, many (read: most) traders discount the role of technical analysis. However, what most traders tend to ignore is the sacred fact that it is fundamental factors that move the market; and no matter how smart you are in marking charts and spotting perfect entries, you are still subject to massive moves spurred by fundamental factors. For instance, the eight-times-in-a-year Federal Open Market Committee (FOMC) meeting of the US Federal Reserve Bank, always leaves massive currency moves in the region of hundreds of pips (within hours) in its wake; this is because it is here that the US main interest rates are set. And interest rates have a major effect on future economic direction – which invariably affect future currency price directions too. If one’s trade is caught in such a move, such a trader will be in serious losses, due to the fact that there are no guarantees that his/her stop loss will be triggered, due to a phenomenon called slippage.
In essence pay close attention to Fundamental analysis for your own good.
Most Important Economic Indicators
Not all economic statistics are really important or relevant to a country’s currency and to the forex market. For instance, Human Development Index (HDI) and Foreign Direct Investment (FDI) figures are important economic statistics, but they are not relevant to the forex market because they don’t seem to have any immediate effect on the market, although they may do in the ultra long-term. Similarly, and surprisingly so, not all fundamental analysis are important for all countries, and realities across countries greatly differ. For instance, news regarding the commodities market may not seem to have any impact on the Great Britain Pound because it is a non-commodity economy. However, they may have great effect on the Canadian Dollar because the Canadian economy depends partly on commodities like oil and metal. As such, it is important to be aware of what matters and focus on it.
However, some news items are quite indispensable in the forex market; it should be noted that we will be using US economic news as examples, because they move the markets the most – and this is as a result of the Dollar’s preeminence in the forex market (it is responsible for 88% of total transactions). They include:
- Unemployment Rate and Labour Statistics
By far, one of the most popular, as traders globally always talk about and look forward to the first Fridays of every month, when the report is normally released. The US unemployment and labour report for each month is called the Non-Farm Payroll (NFP); the NFP report includes the number of new jobs that were created the previous month, the new unemployment rate (in percentage), and the change in the amount of income people earn per time.
Labour statistics are important because they help predict the future buying power of the population, which will affect the strength or otherwise of a currency.
- Interest Rates
Interest rates are basically the percentage of return to be paid per time for money borrowed. Interest rates affect the forex market because they dictate how cheap it is for people to have access to credit, that can be used to spur economic growth. In the US, interest rates are called Federal Funds Rate, and are set by the 12-member FOMC.
Inflation rate measures the change in prices of goods and services over a specific period of time. Just like labour market statistics and interest rates, inflation data is a major market-mover in Forex.
Many central banks and monetary policy makers in developed economies, including the Federal Reserve and the Bank of England, have an inflation rate target. Policy makers try to meet their inflation target by tweaking monetary and fiscal policies.
- GDP Growth Rate
GDP, in everyday terms, may be seen as a measure of how rich a country as a whole; and it is usually measured regularly to see how wealthier the country (and its citizens) have got per time. A positive GDP Growth Rate proves that citizens may be getting richer, translating to higher purchasing power, which helps to power the economy forward, propping up the country’s currency by default. Otherwise, purchasing power reduces and currency does not perform well in the long-term.
By far, the above are the most important economic indicators that cut across most economies. Other honourable mentions which move markets once in a while (depending on the prevailing conditions in the economy at the time) include Business Confidence surveys, Balance of Trade figures, Retail Sales, Purchasing Managers’ Index, amongst others.
Be Aware of Economic Reports before they are released
As mentioned earlier, economic releases like the above may have serious negative effects on your account if you are in a trade when they are released; as such it is advised that you know about them earlier so that you can take necessary precautions (probably closing your trade). You do this by using Economic Calendars; the most widely used calendars include those provided by ForexFactory.com and Investing.com. Typically, these calendars contain the date and time of the news release, their potential impact on the market (designated in colours), the previous figure and forecasts for the forthcoming one.
Don’t Use Fundamentals Alone
We’ve reiterated it over and over. Don’t pick one and leave the other. Balance both Fundamentals and technicals properly and see yourself succeed in the market.
One easier way to succeed in the market, however, is through the use of winning forex trading signals. Copying the trades of veteran and experienced traders will make you profit and make money out of the markets with little or no experience.