Trading in general and trading the forex markets in particular should be made considering both technical and fundamental analysis. Technical analysis represents forecasting prices on the right side of the chart based on different patterns that formed back in time, while fundamental analysis represents interpreting economic news/releases in order to forecast future price movements.
If you want, technical analysis shows the direction, while fundamental analysis represents the reason why a market is moving.
When it comes to the forex market, fundamental analysis is particularly important as each and every currency pair represents two different economies. Therefore, knowing to interpret economic releases for the two currencies should result in having an educated guess about the future direction of that currency pair.
Let’s take the EURUSD for example. This currency pair is moving based on the economic differences between the two economies it represents: the Eurozone and US economies. Therefore, if during the London session, a negative economic news is released, the EURUSD pair is going to move to the downside. However, in the upcoming US session a US economic news may come on the negative side as well. This will result in the EURUSD erasing earlier losses and moving to the upside.
When it comes to fundamental analysis, it all starts with the economic calendar. This can be found for free and represents all the economic data that is being released around the world, on the major economies, and their potential impact on the currency they are referring too.
The economic calendar has a color code based on the importance of the economic event to come, with red showing the most important news and yellow showing news that are unlikely to move markets.
Out of the red ones (the important ones), central banks meetings and monetary policy statements are by far the most relevant as interest rates are the ones that move the forex market.
Therefore, the thing to do is to look when the major central banks are setting the monetary policy and how is the news announced. Major central banks that matter for the forex market are the Federal Reserve of the United States (Fed), European Central Bank (ECB), Bank of England (BOE), Bank of Japan (BOJ), Reserve Bank of Australia (RBA), Reserve Bank of New Zealand (RBNZ), Bank of Canada (BOC), Swiss National Bank (SNB), etc.
All these central banks are meeting on a regular basis to assess the state of their respective economies and to set the appropriate interest rate policy. The higher the rates, the stronger the currency should be, so in between these meetings traders are trying to have an educated guess what the central bank will do and therefore will buy or sell the respective currency.
Beside central banks interest rate decisions, inflation (Consumer Price Index — CPI) release is watched closely by traders and brokers like easymarkets always notice clients about changes in inflation expectations and when inflation is going to be released.
Inflation is important because it is being part of a central bank’s mandate, to keep prices stable. As a rule of thumb, any central bank is trying to keep inflation below or close to two percent.
The higher the inflation goes, the most likely the central bank will come and raise the interest rate at the next meeting and therefore traders will buy that respective currency in advance. The opposite is true if inflation falls further below the 2% target as expectations are growing that the central bank will cut rates so traders will sell the currency prior to the next central bank meeting.
Moving forward, jobs data is critical for any economy so unemployment rates and actual job creation are closely watched as well. Based on how an economy is performing the central bank will change the monetary policy and this is why this is a vital information for forex traders.
In the United States, the jobs data is being called NFP (Non-Farm Payrolls) and it is being released, together with the unemployment rate, every first Friday of the month. This is a key data for the overall forex market as the US dollar is the world’s reserve currency and what happens in the United States will influence the global economy.
Moreover, job creation is on the Fed’s mandate, meaning the Federal Reserve will move interest rates based on both inflation and jobs data. Early signs of jobs picking up at the start of the month will result in traders buying aggressively the US dollar, with the opposite being true in case jobs data disappoints.
Besides the above economic releases, PMI’s (Purchasing Managers Index), GDP (Gross Domestic Product), Retail Sales, etc., are part of the overall fundamental analysis picture forex traders must take into account each and every trading day.
However, fundamental analysis is not only about economic releases, but also about geopolitical risks as well, as markets sometimes move based on news that are not necessarily of economic nature, like wars (e.g. Russia annexing Crimean peninsula), political crisis (e.g. Greek debt problems), referendums (e.g. Brexit vote in the UK), and the list can go on.
What is important is for traders to understand that trading cannot go only with technical analysis as markets move on complex things. Put algorithmic trading and high frequency trading into this picture, and you’ll start to understand why trading forex is one of the most challenging jobs in the world.
Putting all things together is key to any trader’s success and understanding what makes fundamental analysis is one step in the right direction. However, as mentioned here, fundamental analysis on its own is not working and one needs technical analysis as well in order to correctly forecast future price action. Together, they represent the perfect tools to use when trading financial markets.
Summary: Fundamental analysis is one important pillar trading should be based on. There are many things that can impact a currency pair from a fundamental point of view, but everything starts and ends with central banks and what their monetary policy is.