Fundamental Analysis in Forex
In fundamental analysis, forex traders look at the “fundamentals” to estimate the effect on the currency price. What are those fundamentals? There are many, but the most important, the “market movers”, include the following (not in order):
* Economic conditions in various countries
* Stability, or instability, of governments and political environments
* Interest rates in various countries
* Currency supply and demand
* Policies of various governments
* Historic currency performance
* Countries’ deficit or surplus in international trade
* Cost of producing goods — known as PPI
* Consumer price index — known as CPI
* Gross domestic product — known as GDP
Each country’s central bank oversees the economy, and the fundamentals that affect it. The factors are announced by the central banks regularly, sometimes monthly but often weekly, and the exact time of these announcements is known in advance. Another term for these factors is “indicators”, which you will hear often in forex trading.
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You must understand that these indicators are always pretty much expected by the market even before the announcement. Forex traders position themselves accordingly in the market. Indicators that conform to these expectations will cause little effect on the market.
On the other hand, if these expectations are not what actually occur, currency prices will definitely move. That’s what fundamental analysis is all about, and lots of forex traders use this information exclusively in their trading. (This is probably not wise, however, and a combination of fundamental and forex technical analysis is a better basis for forex trading.)
The European Union’s ECB, the U.S. FED, the U.K. BOE and the Japanese BOJ have the most influence of all the central banks. As the saying goes, when they speak, people listen — and also trade!
As might be expected, U.S. indicators have the biggest impact on the forex market. The ECB indicators have less impact, except when they are much different from what was expected. Two of the major economic drivers that affect the forex market are interest rates and inflation, so listen carefully when knowledgeable financial experts talk about them.
Forex fundamental analysis is made all the more complicated because accurate measurement of the variables and their relationships is difficult. Much of the process depends on estimates based on historical experience. What is happening in the world, such as major political events or wars and other international catastrophes, can also cause certain assumptions to be made. But these assumptions often don’t come true, and the markets may lag behind a bit in making adjustments.
There’s nothing more fundamental than supply and demand, and that certainly holds true in the forex market. If currency prices remain at the same level despite a decrease in demand, eventually the price will increase. If the supply increases while the demand stays constant, the price will eventually decrease.
This is a very basic explanation of forex fundamental analysis.
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