Fundamental Analysis in Foreign Currency Trading

Forex fundamental analysis is simply a method of using the “fundamentals” in a certain market to gauge how the currency price will be affected. These are some of the factors to consider in fundamental analysis:

* 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. These factors are called “indicators”.

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Of course, experienced forex traders usually know what to expect of these indicators, and have positioned their trades accordingly. Indicators that conform to these expectations will cause little effect on the market.

But if the indicator that is announced is different from what was expected, you’re more likely to see movement in currency prices. That’s what fundamental analysis is all about, and lots of forex traders use this information exclusively in their trading. I personally, however, recommend a combination of fundamental and technical analysis.

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. Forex traders are wise to pay attention to these bodies in their trading.

As in many business environments, the forex is affected most by U.S. indicators. The ECB indicators have less impact, except when they are much different from what was  expected. When you read the business and financial press, pay attention to senior bank officers talking about interest rates or inflation, as these are seen as the two major economic drivers.

Forex fundamental analysis is made all the more complicated because accurate measurement of the variables and their relationships is difficult. Historical experience is the basis of estimates of the fundamentals. 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. They are, however, only assumptions and they may not happen as expected. It can take a while for the markets to adjust to the reality.

Supply and demand is a basic rule of life, and nowhere is it more normal than in the forex market. If other factors have caused the supply of a currency to decrease but the demand remains at the same level, the price will increase again. The opposite also holds true: if demand stays the same while prices have increased, eventually the price will decrease.

This is the basis of forex fundamental analysis.
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