Trading Aspects for Fundamental Analysis
Whenever, we think or talk about trading the first thing that comes to our mind is that which approach to be used for trading whether fundamental or technical.
Fundamental analysis is a technique of looking at the forex market by analyzing economic, social and political forces that may affect the supply and demand of an asset. Now, in other words fundamental analysis is a way of analyzing potential views of a currency with strength or weakness of that country’s economic outlook. In fundamental analysis, we usually value equities or commodities by their intrinsic strength on an absolute basis, while if we talk about foreign exchange it is valued by the relative strength of one currency with respect to another currency. Here, for forex market we take into account the fundamentals of an economy which includes the economic indicators such as interest rates, employment reports, inflation reports and monetary policies. Trading on the basis of fundamentals also can be referred to as trading the news which means studying the news events and economic statistics to determine the trading opportunities. The fundamental traders usually pay close attention to the changes in economic indicators to initiate a trade.
The forex prices are impacted by macro and micro economic data of an economy, geo-political events and their linkages. These may include the GDP growth rates, employment statistics reports, interest rates and balance of trades. The different types of approaches are used in the fundamental analysis which may vary from trader to trader are discussed as below:
⦁ Top Down Analysis: This approach helps one in looking at a bigger picture for an investment idea and later analyzing the details of smaller components. It begins by taking into consideration the broad macroeconomic factors and then aggregating data by working downwards i.e. by following a narrow and refined approach to search only those currency pairs that present a profit potential.
⦁ Bottom Up Analysis: This approach helps in the decision of an investment idea where one takes the investment decision by starting the analysis with the currency pairs and then moving forward by taking into consideration the various macroeconomic information.
The fundamental traders study the macro-economic indicators and the data which is published regularly at a particular time by the government agencies and private sector. The key figures include data related to labour market, economic growth and trade data along with the retail sales figures and the data of housing market. Fundamental traders follow these data and news announcements regularly in order to get a bigger picture of currency’s strength that uses in relation to other countries. More to the point these events can present a great trading opportunity. After the publication of these data, the traders will observe the volatility of the market. However, the degree of volatility is dependent on the importance of the indicator. That is why one should understand which indicators are important and what they actually represent. Likewise, US data tends to have a greater impact on the financial markets as we know US is the world’s biggest economy. Let us consider some more details about the economic indicators which can impact the prices of forex. The Balance of Trade and Interest Rates are the factors that are the key drivers for currencies. In a situation, if a country has a trade surplus this means there is a higher demand for its goods and services. As a result, greater demand for its currency and driving up the relative value of currency. Similarly, higher relative interest rates which will lead to investment inflows from foreign countries, thus driving the value of the currency higher. Moreover, the interest rate changes by the central bank of a country also influence the forex prices to a larger extend as traders always look for speculation of currency whenever there is any announcement by the central banks for the rate change. Any kind of monetary policy changes by the central banks can add to the wild changes in the forex markets. The GDP of a country influence the forex markets as the shift in the numbers of GDP can lead to price movements in the value of the currency of that country as increase in the value of GDP strengthens the currency of that country whereas the fall in GDP weakens that country’s currency. CPI is the most crucial economic indicator of an economy as it represents the retail prices of a basket of goods and services. If the prices of goods and services for the basket is increasing that means inflation is also increasing. Inflation directly affects the purchasing power of a currency. If an economy develops in no more condition than the increased inflation will lead the central banks to rise the interest rates and increased attractiveness of the currency. To add to it, the forces of demand and supply signify the relationship between the buyers and sellers that help in determination of price. These depend on various macro as well as micro economic factors of the economies that shifts the equilibrium of the demand and supply towards higher or lower end and thus moves the forex prices.
We can conclude Fundamental Analysis as: