A Basic Introduction to Fundamental Analysis Written For The Trainee Forex Trader
By:
Donald Saunders
It is generally said that the secret to profitable Forex trading is information but, despite the fact that accurate and up-to-date information is indeed central to currency trading, it is the examination of this information which is the real key. There are two main types of analysis used in Forex trading � fundamental analysis and technical analysis - and in this short article we look at precisely what is meant by fundamental analysis.
In its simplest form, fundamental analysis looks at political and economic conditions which could affect currency prices and Forex traders who use fundamental analysis rely on news reports for information about a whole range of things including inflation, growth rates, economic policy and rates of unemployment.
Basically, fundamental analysis provides an overview of currency movements together with a broad picture of economic conditions which could well affect the value of a specific currency. With this picture in mind, Forex traders will then often move on to use technical analysis to then plot entry and exit points in the market and to add to the information gained through fundamental analysis.
The foreign exchange market is much like other markets and is affected by the forces of supply and demand, which are also affected by economic conditions. Two economic factors affecting supply and demand are the strength of the economy and interest rates and the strength of the economy is affected by the gross domestic product (GDP), foreign investment and the economy's balance of trade.
Various economic indicators are released by governments and by other sources and are usually held to be good measures of the health of an economy which are followed by all sectors of the investment market. Most economic indicators are released monthly but some are issued more often and normally weekly.
Two of the main fundamental indicators are international trade figures and interest rates, but other very helpful indicators include the durable goods orders, purchasing manager's index (PMI), consumer price index (CPI), producer price index (PPI) and retail sales.
Interest rates are an extremely important indictor because they can have a weakening or strengthening affect on a currency. For example, high interest rates may attract foreign investment and strengthen the local currency, while stock market investors usually react to increases in interest rates by selling in the belief that higher borrowing costs will have an adverse affect on many companies. High volume selling by stock investors can quite often cause a downturn in the stock market and the economy.
International trade indicators are also extremely important to the foreign exchange trader. A trade deficit, with export levels below import levels, is normally seen to be an unfavorable indicator as money flowing out of the country to purchase foreign goods may well have the affect of devaluing the currency. However, fundamental analysis will also indicate market expectations and these will often determine whether or not a trade deficit is unfavorable. It may be the case, for example, that a county often operates on a trade deficit and that this has already been factored into the price of its currency. In general terms, a trade deficit will only affect currency prices where they are above the level which the market would normally expect.
Every country will have its own set of economic indicators (there are currently some twenty-eight major indicators used in the US) and these strongly influence the financial markets. For this reason, Forex traders have to be aware of them and study them carefully when they are preparing their trading strategies.
Luckily, for traders who are working on the Internet, many sites now provide a wealth of the latest information, but it is up to individual foreign currency traders to take this information and then apply the principles of fundamental analysis to it to make their trading decisions.
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