Fundamental analysis is a method of analysing financial markets – such as the forex market – and it involves looking at the underlying economic and financial factors that drive asset value. In the case of forex, these are the factors that affect the price of a currency’s exchange rate with another currency. Many forex traders use fundamental analysis to help them make more informed decisions in the market.
Fundamental analysis involves examining economic data and news events such as GDP, inflation and interest rates, geopolitical developments, and major world events. Understanding how they can affect a currency’s value can lead to traders knowing when a currency is overvalued or undervalued. In other words, it can let traders know when there are good selling and buying opportunities.
There are several approaches to fundamental analysis, which we will explore in this article. If you are keen to start using this tool to make more informed trading decisions, read on to learn more.
Understanding the role of fundamental analysis in forex trading
The first thing that people should know when making a forex investment is what drives prices in the forex market. This means knowing what causes price movements for the currency that you want to trade, and the relationship between the economic data you will analyse and currency prices. This can help you make the most informed trading decisions, as you will be able to better predict price movements in the markets based on real-time events.
4 tips for fundamental analysts trading forex
Below are 4 major tips for fundamental analysts – or those who want to become one – to consider. These should not be construed as advice. Rather, they can serve as a starting point for forex traders who want to consider fundamental analysis but do not know where to begin.
Use an economic calendar
An economic calendar is a tool that keeps track of upcoming economic events and economic releases that may have a significant impact on currency prices. Some examples include the release of national GDPs and inflation and interest rates. These are called economic indicators, and they can impact not only currency prices but the prices of other asset classes such as stocks and commodities.
Traders use economic calendars to plan their trades around these events and announcements. They usually find them from a variety of sources, such as trading platforms, economic data providers, and financial news websites. Remember that not all economic events will have the same impact on the currency that you want to trade. For example, if you are trading the US dollar, the release of the Indian GDP may not have much of an effect on the price of the US dollar.
Follow geopolitical developments
Another important tip that fundamental analysts swear by is keeping on top of geopolitical developments as they unfold around the world. Geopolitical events such as elections, trade agreements, crises, and conflicts can impact currency prices depending on the severity of the situation. Staying informed about geopolitical developments and understanding how they can affect currency value can lead to more informed trading decisions.
For example, elections often lead to changes in government policies and priorities. This can impact the economy of the country. If a new government that comes into power is focused on driving business and development locally and sets a more business-friendly agenda, it can lead to more job creation and more economic activity and growth, which can lead to a currency appreciating. If a new government that comes into power is unstable or unpredictable, it could lead to decreased investment and interest from consumers and other countries and result in a weaker currency.
Another example is the topic of trade agreements. These are legal agreements between countries to import and export goods and services, and depending on the terms of the agreements, currencies can appreciate or depreciate. If Singapore signs a trade agreement with Australia that opens up new markets for Australian exports, it could lead to increased economic activity for both countries. Conversely, if it imposes restrictions on Australian goods and services, it could lead to decreased economic activity and a weaker Australian dollar.
Monitor central bank announcements
Central banks are major participants in the forex market, and they play a central role in setting monetary policy and interest rates. These policies affect the supply and demand of a currency in the forex market, which can affect its interest rate. The main objective of central banks is to maintain price stability and control national inflation, and they may adjust interest rates and change reserve requirements for banks to achieve their goals.
For example, forex traders should pay attention to when central banks increase or lower interest rates. A lowered interest rate can make borrowing cheaper, which can lead to increased economic activity and increased consumer spending, business investment, and job creation. This can lead to an increase of the value of the local currency. Yet, when interest rates are too low, it may lead to inflation when the demand for goods becomes much greater than their supply.
Conversely, when a central bank increases interest rates, it can lead to less borrowing activity and slow down economic activity. This can be a solution to controlling inflation, but it also leads to the reverse of the previous situation described. There will be decreased consumer spending and business investment, which can lead to the local currency depreciating in the forex market.
When forex traders pay attention to the monetary policy announcements from central banks, they can make more informed currency trading decisions.
Use diversified sources of information
Finally, it is essential that forex traders use diversified sources of information. This means not obtaining all their information and data from one place, and instead cross-checking between various websites. This is because no single source of information is perfect or comprehensive. Forex traders should include different news sources, economic reports, and expert analysis types before trading currencies.
Using other forms of analysis alongside the fundamentals
Even though fundamental analysis can provide great insight into how the markets may perform and give traders plenty to go on in the forex market, traders should employ it alongside other forms of analysis. This includes technical analysis and sentiment analysis. This means reviewing price charts – both present and historical – to find patterns and trends. It also means learning about how other investors are feeling towards a particular currency or asset. The forex market is decentralised, and the actions of other traders can impact the price of a currency – even if just by a little. Being aware of technical and sentimental factors can lead to even better trading decisions in the forex market.
The bottom line
Fundamental analysis is a great way for forex traders to gain a firm grasp on predicting forex movements. However, it is not a perfect way, and the forex market can still be unpredictable. Therefore, traders should not solely use fundamental analysis but branch out to other forms of analysis, such as technical and sentiment. There is also an advantage in implementing proper risk management strategies when placing trades, regardless of how confident a trader may be in in their trades. This can protect against unexpected losses and help traders make the most of their forex trading portfolio.