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In trading currencies, we are dealing with a financial product. The movement of this product is dictated by differences in supply and demand. And these two are influenced by underlying external fundamental factors. These fundamental factors are mostly economic, usually represented in the form of financial/economic data reports; however these factors could also be political and geopolitical events as well as natural phenomena such factors will move the price of one currency against another in the context of a currency pair.
The state of the economy is usually described in financial reports which analysts study to predict price reaction and currency value in relation to other currencies. As such, for analytical purposes, analysts are interested in the Gross Domestic Product (GDP), level of interest in the economy, unemployment, inflation, Balance of Payments (BOP), political stability, budgetary deficits, and public debt reports. It is the analysis of these factors that’s referred to as Fundamental Analysis.
Fundamental analysis in general terms is the examination of the economic factors that determine currency rates on the Forex market. A combination of all external factors that can influence a currency or a currency pair are taken into account and used as a basis for this analysis.
As seen above, there are a number of factors to consider but can be grouped into just three factors that you must understand to ably and accurately analyse and interpret fundamentals of the financial markets. These are mainly economic factors, Central bank, and politics
These are indicators of the health of the economy such as:
These play an oversight role in the economy. They determine the interest rate which a direct effect on inflation. Rising inflation collapses the value of the domestic currency. This depreciation in the currency value affects investment flows into the economy
A country’s political state can affect its currency strength. Investors are attracted by the stability of a nation politically. This increases foreign capital gained from their investments which in turn leads to the increase in the value of its local currency. General elections, financial crises, and wars – all create uncertainty. This negatively impacts on the level of activity and investment within the economy as investors become risk averse. In turn, it could lead to depreciation in exchange rates.
The breed of traders coming onto the market today tends to focus most on the technical aspect exclusively. What they fail to realise is that the movement of price, along with market structure resulting from these price moves, and everything they see technically on the charts is just an expression of the underlying cause, which cause if they understood would aid their trading and improve their results exponentially.
Prices move due to reactions towards price-moving events by market participants. The Forex market is so big and the liquidity so humongous the market doesn’t just move at the whims. Its intentional. Until you understand the fundamentals of the market, trading can be abit challenging.
As a trader, you need to understand the macroeconomic factors and how they influence price moves. Fundamental news events and the analysis thereof are the reason prices change and the market moves. Traders study factors and events their likely impact on demand and supply of currencies.
This is aimed at understanding why prices move. Reports are released periodically through news events and such are some of the the most market moving events. Investors and traders research reports, statements, speeches, and comments made by the people believed to be privy to yet to be released reports and data and impending economic decisions to get clues of what the outcome of such reports might be and what economic decisions are in the offing. This helps them to predict next currency moves enabling them to place trades way ahead of the crowd long before such events happen.
These events are graded or classed in terms of impact on the movement of prices. And below are what i believe to be the top market moving news events:
Speculators look at a currency’s interest rate to anticipate the direction a currency might move. It is one of the biggest determinants of the perceived value of a currency when it comes to trading Forex. Hedge funds and institutional investors read into these interest rates to invest in currencies. When the rates are high, the value of the currency rises and when they’re low the currency value is low as well. As such, when the interest rates are rising in one country, hedge funds, banks and big institutional investors will buy that country’s currency.
This flow of money has a great influence on the value of that currency as the buying interest rate pushes up the value of that currency. Remember investors and traders prefer economies with high interest rates. Why? It’s a money thing. It’s about earning. Traders interpret high interest rates of a country to mean high demand of that particular country’s currency.
And as such they will buy it. and as more and more people buy and hold their long positions for an extended period, it tends to create a long-term trend of that country’s currency over other currencies its paired with.
This is an indicator of economic growth. It’s a monetary benchmark of the total production within a country. Forex traders use it to determine the growth and value of an economy and relate such to the strength or weakness of a currency to determine their directional biases in trading decisions.
For example, let’s say a trader is looking to trade the GBP/USD pair. And lets hypothetically assume the British pound (GBP) has a growth rate of 7% and the U.S. dollar (USD) has a growth rate of 3%. The net difference between these two is 4% with the GBP being the base currency in the pair (again these are just hypotheticals). The net differential in such a case being positive would indicate a long (bullish) bias on the currency. Had the differential been negative it would indicate a short (bearish) bias
This is a measure of the aggregate price level in the economy. It examines changes in the purchasing power of a country’s currency by averaging prices of commonly purchased consumer goods and services. The index is usually computed for a particular period of time, say a month, as a weighted average of prices for components of consumer expenditure, such as food, housing, shoes, clothing, Medicare, transport, etc. Consumer Price Index (CPI).
This is a measure of the aggregate price level in the economy. It examines changes in the purchasing power of a country’s currency by averaging prices of commonly purchased consumer goods and services. The index is usually computed for a particular period of time, say a month, as a weighted average of prices for components of consumer expenditure, such as food, housing, shoes, clothing, Medicare, transport, etc.
The CPI data is reported monthly by the US bureau of Labor Statistics. The CPI data is a very good indicator of the inflationary levels in the economy as it reflects both the increase and/or reduction of the cost of living. This in turn indicates a growing or collapsing economy in terms of strength or weakness based on consumer power. As such, it’s a very important piece of financial data that central banks rely on to determine interest rates as a means of controlling inflation.
Given this, traders in the Forex market are keen on the data releases to speculate the strengthening or weakening of a currency as it gives an early warning of what policy decisions the Central bank might come up with which affects/influences the perception of the strength or value of a currency
The unemployment rate is the percentage of the labor force that is jobless. It is released by the Bureau of Labor and statistics. It represents the percentage of people actively seeking employment and willing to work. This report monitors the past performance of the labour market and measures the number of unemployed people by deducting the people who found a job and adding the people who recently started to look for work. It is basically the percentage of the unemployed in the total workforce of a country.
This data is so important to speculative traders in their fundamental analysis. It’s an important indicator of the strength of the economy and therefore the nation’s currency. The more the employment the more vibrant the economy is perceived to be as it indicates growth and strength, and vice versa. Suffice to say the employment numbers is one of the primary drivers of a nation’s currency.
Its common knowledge to anyone with a little hint of economics that the more the people employed the more the power of the population (consumers) to spend. This therefore has an impact on the Consumer Price Index (CPI) that we discussed above. As more people are employed increasing the spending ability, it directly affects the inflationary rates in the economy which impacts on the nation’s currency. To control this,… now you know where im going …. the central bank comes in with interest rates policy decisions.
So the US employment situation report is so important when analysing fundamentals. A vibrant economy has excellent employment numbers with low unemployment and numerous employment opportunities. To a Forex trader, the Non-farm payroll report is the most important in determining the strength of the economy
The FOMC holds a number of scheduled meetings regularly every year. During such meetings, economic and financial conditions are reviewed to determine the necessary monetary policy position to take aimed at promoting stability of prices and sustainable economic growth. Its voting membership is composed of seven members of Board of Governors, the president of the Federal Reserve Bank of New York, and four other reserve bank presidents.
FOMC meetings are attended by all other reserve bank presidents who may not be designated voting members that particular year. The total number of research Bank presidents is twelve. The FOMC meets eight times a year.
This is an indicator of economic growth. It’s a monetary benchmark of the total production within a country. Forex traders use it to determine the growth and value of an economy and relate such to the strength or weakness of a currency to determine their directional biases in trading decisions.
For example, let’s say a trader is looking to trade the GBP/USD pair. And lets hypothetically assume the British pound (GBP) has a growth rate of 7% and the U.S. dollar (USD) has a growth rate of 3%. The net difference between these two is 4% with the GBP being the base currency in the pair (again these are just hypotheticals). The net differential in such a case being positive would indicate a long (bullish) bias on the currency. Had the differential been negative it would indicate a short (bearish) bias
In strong economies such as the US and EU, these have the ability affect the value of a currency against others. Such events surrounding politics and geopolitics can shift the value of one currency against another. traders analyse such events around a currency pair. This could be referendums, executive orders, elections, war related decisions, etc.
These are beyond the control of man. They are unexpected events that occur as forces of nature such as floods, earthquakes, tsunamis, volcanic eruptions, floods, etc. These have the potential to collapse entire economies of cities or regions through the disruption of economic activities and sometimes the complete destruction of livelihoods. they have the ability to bring about extremely big moves in the market and sometimes even gaps. And the fact that they occur suddenly many times for the shortest of spans and yet huge changes in price is the reason fundamental analysis is critical to the trading of currencies.
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