What is fundamental analysis in trading?
If you’re new to Forex trading, there’s no doubt you’ll be faced with the challenge of understanding key Forex terms. Truth be told, there are tons of trading terminologies you should familiarize yourself with.
In this detailed post, I’ve explained a key concept and term in Forex trading that you must be aware of, and understand. It is called Fundamental Analysis.
What Exactly Is Fundamental Analysis?
By Fundamental analysis, we mean studying the effects of economic news worldwide and other events on different financial markets.
It mostly involves news events, company profits and news, economic announcements, social force and the vital parts of fundamental data that is applicable for the Forex market, which works as an interest rate policy and the country’s interest rates.
The main idea behind fundamental analysis is that if the present or future economic scene of a country is good, it can easily strengthen its currency.
With a strong economy, you can easily attract businesses and foreign investments meaning that foreigners need to buy a particular country’s currency for investments or begin with a business.
So, essentially, this all this ultimately narrows down to the demand and its supply. Countries having an increasing and growing economy experience stronger currency demand, which ideally works well for lessening supply while driving up the currency value.
Let’s suppose if the Australian economy gets better, the value of the Australian dollar increases in relation to all other currencies.
The main reason for a country’s currency gaining more value with its growing economy is because the country raises interest rates for controlling inflation and growth.
Foreign ministers are drawn to higher interest rates and as an outcome, they have to purchase Aussie dollars for investing in Australia, this will surely surge the demand and currency price while lessening its supply.
Important Forex Economic Events
Get this straight.. Fundamental analysis is news trading and news are being released from time to time with certain news calendar to follow.
Let’s quickly move on to a few vital economic events that directly affect the price of Forex. With this, we’re going to familiarize you with a few jargon that you’re likely to see across your Forex journey.
Besides getting aware of the times these get released on a monthly basis, these economic events can easily be found daily if you head on to sites like forexfactory.com, mql5.com.
1. The GDP (Gross Domestic Product)
The reports and findings concerning Gross Domestic Product are among the most vital economic indicators among all others. GDP is the largest measure of the overall economic state.
The numbers for GDP are out at 8:30 am Eastern Standard Time on the last day of the quarter while it also reflects the activity of the previous quarter.
The GDP can be said as the aggregate (total) monetary value of all other services and goods that were produced by an economy as a whole at the quarter getting measured.
However, this doesn’t involve any international activity. The rate of GDP growth is a vital number that we have to always consider.
2. Trade Balance
Another major economic news event you can trade is what’s called Trade Balance. Trade balance can be termed as the amount of difference between the import and the export of tangible services and goods.
A country’s trade balance with changes taking place in exports vs. imports is always considered and these also indicate a country’s total economic strength.
It’s always better to have higher exports compared to imports. A country’s economy inclines with its exports and it also shows the current economic state of the manufacturing sector.
3. CPI – Consumer Price Index
A common tool to measure inflation is the CPI report. The report is available at 8:30 am morning EST b 15th of every month and this also has data for the previous month. CPI measures changes in costs of consumer goods bundled with monthly services.
4. PPI – Producer Price Index
PPI is also an important tool for measuring inflation. PPI report is out at 8:30 am Eastern Standard Time at second full week of each month.
It also shows data from previous month. PPI measures wholesale prices for goods. So here you get the amount producers receive for the goods while with CPI, the amount consumers paid for goods is measured.
5. Employment Indicators
The Employment announcement is made in morning 8.30 Eastern Standard Time zone at every month’s first Friday. The announcement is for workforce percentage, total number of jobs, unemployment rate, average hourly earnings and average weekly work hours.
Traders and analysts also talk about NFP meaning Non-Farm report for employment. The report can considerably affect markets.
6. Durable Goods Orders
The report for durable goods orders provides measurements on long term purchase expenditure by people, specifically for products lasting higher than 3 years.
Markets release the report at 8:30 am Eastern Standard Time zone every month around 26th. It also provides insight on manufacturing industry.
7. Retail Sales Index
Retail sales index tells the amount of retail industry goods sold. Its release time is 8:30 am, zone Eastern Standard Time, 12th, every month. Previous month data is available. The report goes through several revisions.
8. Housing Data
The report is for new homes built within a country for a particular month with existing sold homes. With existing home sales you can easily measure a country’s condition. Low home income stats and existing low home sales indicate a sluggish economy.
9. Interest Rates
Interest Rates largely drive Forex markets. All the aforementioned economic indicators are watched closely by Federal Open Market Committee for gauging overall economic health.
The Federal Government of each economy use such tools at their disposal for lowering, raising or bringing no change in rates of interest. All economic indicators are also vital.
Comparing Fundamental Analysis Over Fundamental vs Technical Analysis
Fundamental and technical analysis are two major principles in financial market investment and trading. Analysts check on a market’s price movement and also use the information for making predictions regarding price direction.
As any major global event impact financial markets, any news can be said as economic news. Most fundamental analysts seem to ignore this fact.
Among the major reasons as to why it’s better to primarily trade with technical analysis is that a lot of world variables (economic events) can simply affect global financial markets in a single go.
Now, as Forex rates can considerably change with macro events such as changes in policy and interest rates, but other news such as natural disasters and wars can also shift figures in Forex markets.
As a lot of world events can be related to price and you can’t predict it, there isn’t any reason to follow up with economic events daily for successful trading.
Also, price data cannot be foretasted and instead, you need to use impending or future news (fundamentals) for prediction of price movement in the market.
So, it’s quite good to provide response to two different arguments against all technical analysis.
Fundamental analysts consider past price data not to be a vital factor but horizontal support and resistance are also significant.
Trading can be a simple task with some powerfully predictive action signals for price:
Resistance and support levels should be carefully watched. Fundamental analysts, who insist that charts aren’t important, are plainly wrong. It takes a little time to study price charts.
Another argument used by fundamental analysts is that market price movement can be analyzed by awaiting Forex news. People who’ve traded for long are familiar with market movement and know that it reacts the other way. Sometimes it doesn’t.
We all know that the market is unpredictable, isn’t it?
Markets operate on future expectations. Strangely most people ignore technical analysis and overlook it while trading or analyzing markets.
For example: If payrolls for non-farm are available and the market expects 100,000 added jobs last month, it has most likely already shifted in expectation of such number.
So if the actual number remains to be even 100,000, the market is likely to get lower, rather than being on the higher side as no more than expected jobs were available.
While this might sound like a good figure, it will still be bad for traders and investors as actual report didn’t exceed their expectations. (This might be a little bit confusing for some).
Also Read: Which are the most active Forex trading hours?
Conclusion on Meaning of Fundamental Analysis
As all preceding expectations are already visible and carried out on price chart, it is better to learn and analyze trading through price action available on price chart.
Even after the release of news, we can simply make use of technical analysis for trading price movement, as it is the most practical, clear and usable way for trading and analyzing markets.
This doesn’t mean that you should completely ignore fundamental analysis as it can be complemented with technical analysis as well. However never solely depend on Fundamentals for trading or predicting markets.
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