What is fundamental analysis in forex trading?
Here is one of the most common questions for those interested in forex trading: ‘What is fundamental analysis?‘
Fundamental Analysis Defined
A currency is a good, service, or tradable financial asset accepted as a means of payment and can be exchanged for another currency. The fundamental analysis will refer to methods used to forecast how the trend in the value of a currency could move based on economic factors such as inflation reports, interest rates, GDP figures, etc.
Regarding equities, it would be earnings reports, the direction these forecasts may or may not consider technical factors such as supply and demand, current position in a trend, etc. This type of analysis provides valuable insight into where a currency will move in its basic form.
Using fundamental analysis an indicator
It is advisable for those new to forex trading to use fundamental analysis as an indicator and then pair this with technical analysis that focuses more on the supply and demand aspects of currencies and their relationship. This way, one can get a balanced view of future price movements.
In its purest sense, the beauty of fundamental analysis is that we are not limited to economic factors themselves but rather look at the overall economy itself, including social, political, and technological factors (but not limited to). These all come together to make up what would be referred to as ‘the economy‘ – something we experience every day in our lives even if we don’t realise it.
Here’s some information on the basics of forex trading.
Many people following ongoing economic trends will use it in conjunction with technical analysis when planning their trades. It allows them to make wiser decisions about when to enter and exit trades because they can be better informed about what factors may affect prices in the future.
Here’s an example: If there is political unrest in a big country in terms of its economy, it could lead to disruption in trade, leading to uncertainty. It may cause the price of the currency involved in the disruption (and others) to fall due to investors wishing to sell off currencies until things become more apparent and they know where things are headed. However, if there is a determination on behalf of economic powers, the currency’s price may rise again.
Those who use fundamental analysis to trade are often referred to as “Fundamental traders”. It is not uncommon for these traders to have multiple monitors up with economic calendar dates, streaming news and financial reports all readily available. It allows them to react quickly to sudden changes in prices because they can see events that lead up to it rather than just reacting emotionally to the market itself.
Here’s an example: Let’s say a fund manager has been following unemployment rates very closely within a specific country over the past few months because he knows how this could affect GDP figures, which may trigger interest rate rises or falls, affecting specific ways. He sees some surprising figures come through and immediately makes a call with his brokers to sell off the currency with the surprising figure. He is now ‘short’ this currency.
However, another trader who looks at graphs and pictures of economic events rather than actual numbers will not see the same thing as the fund manager here. He may be able to see that there was little in the way of figures that would indicate an exciting change in figures were on their way or that something had happened which could affect them. He would then decide not to short that currency pair and therefore has different positions to those who did listen to the fundamental analysis forecasts (in this case, they are long).
While it is essential at any stage in your forex trading career to get a balanced view of the market, this type of analysis will often give you the best insight into where prices may go before they happen because you are making judgements based on how others around you are likely to react.