The Fundamental of Forex Fundamentals.
Trader in the foreign exchange market (forex) rely on the same two basic forms of analysis that are used in the stock market: fundamentals analysis and technical analysis.
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The uses of technical analysis in forex are much the same: the price is assumed to reflect all news, and the charts are the objects of analysis. But unlike companies, countries have no balance sheets, so how do you conduct fundamental analysis on a currency?
Fundamental analysis is about determining the intrinsic of an investment, and its application in forex entails looking at the economic conditions that may affect the valuation of a nation’s currency.
Below, we will discuss some of the major fundamental factors that play a role in a currency’s
movement.
Key Takeaways.
- Foreign exchange, or forex traders, rely on technical and fundamental analysis
- techniques that are similar to those used in the stock market.
- In forex, a fundamental analysis might involve looking into the economic conditions that affect the value of a particular country’s currency.
- Major economic indicators such as industrial production, Gross Domestic Product (GDP) and Consumer Price Index (CPI), among others, can provide insight into the state of a country’s economy.
Economic Indicators
Economic indicators are reports released by a government or private organization that detail a country’s economic performance. These reports directly measure different aspects of a country’s economic health.
Economic reports are released at scheduled times, providing the market with an indication of whether a nation’s economy has improved or worsened. The effects of an economic release on the forex market are comparable to how earnings reports, SEC filings, and other releases may affect stocks. In forex, as in the equities market, any deviation from the norm can cause large price and volume movements.
Gross Domestic Product (GDP)
GDP is considered the broadest measure of a country’s economy, and it represents the total market value of all goods and services produced in a country during a given year. The GDP figure is often considered a lagging indicator, and most traders focus on the two reports that are issued in the months before the final GDP figures: the advance report and the preliminary report. Significant revisions between these reports can cause considerable volatility. The GDP is somewhat analogous to the revenue of a publicly traded company in that they are both measures of internal growth.
Retail Sales.
The retail sales report measures the total receipts of all retail stores in a given country. This measurement is derived from a diverse sample of retail stores throughout a nation. The report is particularly useful as a timely indicator of broad consumer sending patterns and is adjusted for seasonal variables. It can be used to predict the performance of more important lagging indicators and to assess the immediate direction of an economy. Revisions to advanced reports of retail sales can cause significant volatility.
Industrial Production
This report shows a change in production levels of factories, mines, and utilities within a nation. It also reports their “capacity utilization” the degree to which each factory’s capacity is being used. It is ideal for a nation to see a production increase while being at its maximum or near-maximum capacity utilization.
Traders using this indicator often pay close attention to utility production, as utilities are closely intertwined with energy costs, which in turn depend on the weather. Unexpected weather events can result in significant revisions in upcoming reports and cause volatility in the nation’s currency.
$1.17 trillion
The average daily volume of the Forex market in North America, as of April 2024.
Consumer Price Index (CPI)
The CPI measures changes in the prices of consumer goods across 200 different categories. It is the most widely used measure of inflation, and is closely followed by not only forex traders, but also by policymakers, businesses, and consumers. CP| readings can have a major effect on forex and broader financial markets, as it is one of the key metrics central banks consider when making a decision on interest rates.
Other Economic Indicators.
Other major indicators include the purchasing managers index (PMI), producer price index (PPI), durable goods report, employment cost index (ECI) and housing starts. There are also variety of privately issued reports, the most famous of which is the Michigan Consumer Confidence Survey. All of these reports can be a valuable resource to traders.
Using Economic Indicators
Since economic indicators gauge a country’s economic state, changes in the conditions reported will directly affect the price and volume of a country’s currency. It is important to keep in mind, however, that the indicators discussed above are not the only things that affect a currency’s price. Third-party reports, technical factors, and many other factors also can drastically affect a currency’s valuation.
If you’re conducting fundamental analysis in the forex market keep the following in mind.
- Keep an economic calendar that list major economic indicators and when they are released. Also, keep an eye on the future forecasts; often markets will move in anticipation of a certain upcoming report..
- Be informed about the economic indicators that are capturing most of the market’s attention at any given time. Such indicators are catalyst for the largest price and volume movements. For example, when inflation is high, the CPl is one of the most watched indicators.
- Know the market expectations for the data, and then pay attention to whether the expectations are met. A beat or a miss is far more important than the data itself. Occasionally, there is a drastic difference between the expectations and actual results. If so, be aware of the possible justifications for this difference.
- Don’t overreact. Often numbers are released and then revised, and things can change quickly. Pay attention to these revisions, as they may be a useful tool for seeing the trends and reacting more accurately to future reports.
What Are the Risks of Forex Trading?
Foreign exchange, or forex trading can be highly profitable, but it also entails risks that are not present in other markets. Unlike domestic stock trading, forex traders are also exposed to currency risk when the value of a foreign currency goes up or down. In addition, forex brokers may offer extremely high leverage, which can easily wipe out an unlucky trader if the markets move against them.
How Do Forex Traders Make Money?
Forex traders make money by betting that the value of a country’s currency will rise or drop relative to another’s. For example, a forex trader might trade euros for dollars if they believe the euro markets are likely to face a downturn. Forex traders can also profit from interest rates-if a country’s central bank raises the interest rate, the value of that currency will likely appreciate.
What Is Fundamental Analysis in Forex Trading?
Fundamental analysis is the practice of examining the intrinsic features of an asset to determine its value, rather than historical price action or market sentiment. In securities markets, this entails looking at a company’s balance sheet to assess its future profitability. In the forex market, traders conduct fundamental analysis by looking at economic indicators and other metrics to project its trajectory in the world market.
The Bottom Line
There are many economic indicators and private reports that can be used to evaluate forex fundamentals. It’s important to take the time to not only look at the numbers but also understand what they mean and how they affect a nation’s economy.
When properly used, these indicators can be an invaluable resource for any currency trader.