What Is Fundamental Analysis

Forex fundamental analysis is the study of the economy of a particular country or region to assist a trader with trading their currency. Forex fundamental analysis uses various indicators and economic data or a series of economic data for that particular currency.

Some of the most important announcements fundamental traders watch for include: Apply for a live account now and you could be trading in minutes Open a live account Trading involves significant risk of loss. These have a significant impact on the valuation of commodities.

Forex Fundamental Analysis. Basics

Fundamental analysis is a way of looking at the forex market by analyzing economic, social, and political forces that may affect the supply and demand of an asset. If you think about it, this makes a whole lot of sense! Just like in your Economics class, it is supply and demand that determines.

One of the most influential of the economic indicators, GDP measures the total value of all goods and services produced by a country during the reporting period.

An increase in GDP indicates a growing economy, and for this reason, GDP is used to measure the level of inflation within the economy. Measures the cost to buy a defined basket of goods and services. It is expressed as an index based on a starting value of By comparing results from one period to the next, it is possible to measure changes in consumer buying power and the effects of inflation.

Inflation is a concern to currency traders as it affects the price of everything bought and sold within an economy, and this has a direct impact on the supply and demand for a country's currency. Inflation is an increase in the price of goods and services. While inflation by its very definition suggests economic growth, inflation that occurs too rapidly actually weakens consumer buying power as prices increase at a faster rate than salaries.

Also an inflation indicator, the PPI tracks the changes in prices that producers receive for their products.

Expressed as an index relative to Excludes volatile items such as energy and food to avoid distorting the index. By measuring the prices received by domestic producers, it is possible to project how the consumer-level prices could be affected.

Employment reports have an immediate impact on currencies because employment levels directly affect current and future spending habits. An increase in unemployment is a negative indicator as it implies that more people are not receiving a regular salary.

This is a sure signal that consumer spending will decline. Most Central Banks maintain a "benchmark" interest rate. Depending on the jurisdiction, the Central Bank rate serves as the guide for the rate at which the Central Bank and other commercial banks lend each other funds to meet short-term operational needs. Commercial lending rates are also affected by the Central Bank rate, and it is this linking of short-term rates to the commercial rates that makes interest rate policy the primary monetary tool for Central Banks.

As noted earlier, the Central Bank can increase rates during periods of high growth inflation in a bid to reduce consumer spending which should help bring growth back to a more manageable level. If deflation is a problem and the economy needs a boost, Central Banks can lower interest rates to entice more consumer lending.

The expected outcome is that overall consumer spending will increase as consumers have access to less costly loans. Forex traders in particular pay close attention to changes in interest rates as investors tend to seek out currencies offering higher returns and this demand can cause a currency to appreciate.

Also, the greater the interest rate differential between two currencies, the greater the profit potential of a carry trade strategy. Yield is the interest on fixed-income securities which includes such investments as futures contracts and government bonds. Referred to as "fixed" income because the payment stream the yield remains constant until maturity. The yield curve shows the relationship between the yield, and the time to maturity.

When dealing with fixed-income securities, investors want to ensure that the fixed yield remains profitable right up until maturity. As an investor you may be happy with a 5 percent return when the basic lending rate is 2 percent. However, if short-term interest rates rise and the lending rate jumps to 6 percent, your 5 percent return is no longer so attractive, and there are probably other options that could generate more income for your investment.

Liquidity spread is the term used to describe the difference between the yield and short-term rates. If short-term interest rates rise above the fixed yield, the bond holder is said to be in a position of negative liquidity spread. When plotted on a chart, the yield is represented along the y-axis, while time to maturity is charted vertically on the x-axis. This results in a yield curve shape that some investors suggest offers insight into future interest rates.

Consider the following so-called "normal" yield shape: The maximum maturity is one year, but the 3-month T-bill is a popular choice for short-term investment. Unlike bonds that pay a regular, fixed-rate amount, T-bills are sold at a discount to par the "face" value. At maturity, the buyer receives the full face value of the T-bill.

Compares the total value of imports to the total value of exports for a reporting period. A negative value indicates that more goods were imported than were exported a trade deficit — while a positive trade balance means that exports exceeded imports a trade surplus.

If the balance of trade shows a surplus or declining deficit, then there may be an increased demand for the currency. If the report shows a growing deficit, then the increased supply — together with a decrease in demand for the exporting currency — could lead to a devaluation against other currencies. Learn the basics here. Elections, for example, are closely watched by fundamental traders.

Even the run up to an election, with campaign announcements, can have a strong effect on a currency. Any major geopolitical event is sure to affect all the major currency pairs. Any major conflict or war nearly always moves the currency markets — it has often had the effect of driving up the US dollar, but this seems to be changing. Oil is priced in US dollars, but changes in its value now affects nearly all the major currencies in one way or another — it is necessary to observe the changes over time to formulate a strategy.

Major macroeconomic changes are also something that fundamental analysts keep a close watch over. If global economic growth is set to slow, then some economies will perform better than others during the recession. If commodities prices rise sharply, then economies in developing nations are likely to perform better, so their currencies should climb in price. If Germany sees good export sales, then all of Europe benefits, and the euro rises.

The fundamental trader has a lot to pay attention to. There are no real rule books for how to trade fundamentals, so you have to develop your own approach, and your own specific strategy. One thing all fundamental strategies have in common is that they are all based on observation and experience, as the relationship of news or economic phenomena and the market is a complex one. Your capital is at risk. The information contained in this publication is not intended as an offer or solicitation for the purchase or sale of any financial instrument.

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