Fundamental analysis in Forex trading requires that you analyze economic indicators such as, Interest Rates, Gross National Product (GNP), Retail Sales, Consumer Price Index (CPI), Non-Farm Payroll and so on.
Fundamental analysis in forex trading is one of the components of forex strategies. Just as there are strategies in running businesses there are forex-trading strategies too, namely forex-trading strategies based on fundamental analysis, and those that are based on technical analysis. We just learnt of pivot points, charts, resistance level and so on, which all comes under the category of forex technical analysis. What then is fundamental analysis? Fundamental analysis is simply the larger picture. It is an economic evaluation of the countries whose currencies are traded in the forex market. For example if we were to consider GBP/USD, a comparative analysis of the economic data pertaining to England and US would indicate to us which way the Pound would move in relation to the Dollar. From time to time, the Central bank and regulatory authorities of most countries whose currencies are traded in the forex market release data pertaining to the economic indices of their respective countries. Based on an analysis of these economic indices, supporters of fundamental analysis formulate their own view of the overall health of a country’s economy. This is how they predict price trends in forex.
Fundamental analysis of forex markets tends to help the long and short-term forex trader alike. For example, crucial data releases by central banks are followed by appropriate responses in the currency movements. Fundamental analysis pertains to news releases and certain economic indicators. Some of these indicators you need to be familiar with are Interest rates, Gross National Product (GNP), Retail Sales, Consumer Price Index and Non-Farm Payroll. It is advisable to know something about each of these indicators, and hence a brief explanation of each of these indicators is given below.
You must be wondering what interest rates have got to do with forex trading. Now, just as Central banks around the world take monetary policy decisions based on the price of their currencies, the reverse could also happen. For example interest rates could affect currency prices. The same way, a strong currency could bring down inflation, while a weaker currency could increase inflation.
In simple terms, GNP means the total income earned by a country’s permanent residents whether they are within the country or outside the country. All you need to remember is that, GNP is released every quarter, and you could take it as a general economic indicator. Here again, the likely direction of the forex markets on release of this data is usually linked to other data releases. This is something you ought to learn with more and more of practice.
Most of the countries whose currencies are traded in the forex markets often release economic reports generally referred to as Consumer Price Index (CPI). The CPI reckons with the average price level paid by the common consumer for basic goods and services, comprising a variety of items ranging from food to medicine to house prices. After assessing changes in prices for these items, the report estimates how much inflation is taking place in the economy. Rising inflation means there are less free money for retail sales and even lesser money for economic growth. In recent times the large spike in oil prices has affected CPI. It quite simply means that there is less disposable income with the working class and everything from transportation to food to retail sales is affected. So as a Forex trader, CPI will give you critical information about a nation that could directly affect the nation’s currency in the Forex market.
More that three fourths of economic activity in the US is made up of consumer spending of which a third relates to retail sales. In simple terms, the retail sales report is an indicator of changes in consumer spending patterns. How do you interpret the retail sales report for your forex trading purpose? It is indeed difficult as it could be interpreted in two ways. All you need to remember is that a strong retail sales number is usually bullish for the dollar. But here’s a catch. If for the same period imports into the country were also high then it could have just the opposite effect on the dollar and it could become bearish in outlook. As you trade the forex you will gradually latch on to the nuances of the Retail Sales report.
This is also referred to as the Unemployment Report. It is one of the most anticipated economic reports for forex traders and is released at different times for different countries. The U.S Bureau of Labor Statistics releases the Non-Farm Payroll Report on the first Friday of every month and what you need to know is that it affects the short term action in the Forex market specifically in regards to the U.S. Dollar. But you need to be careful here. For example if you were trading the US Dollar and the Euro you need to reckon with the Non-Farm Payroll report released by the European Union too. So juxtaposing these two data releases on different days and then correctly predicting the currency movement is indeed an art that is best learned by practice.
What is the difference between fundamental analysis and technical analysis in forex trading? Technical traders use charts, Fibonacci and so on to trade the forex, while traders who use fundamental analysis look at GNP figures and changing interest rates and so on. While technical traders look for market trends, fundamental traders view the overall health of the economy and thereby predict price trends. In other words, while the former suggests that price trends follow certain patterns, the latter looks towards economic data releases to predict possible price trends. Ideally you need not be worried about technical analysis or fundamental analysis per se. But the most important point is, you should figure out which of these strategies adapts to your mind and your way of thinking in a natural sort of way. As a forex trader this is something, which you alone can figure out.