Forex Fundamental Analysis
A Breakdown of the Forex Carry Trade The currency carry trade is a strategy in which a trader sells a currency that is offering lower interest rates and purchases a currency that offers a higher interest rate. The list of actions they can take is vast; they can raise interest rates, lower them even into negative territory , keep them the same, suggest their stance will change soon, introduce non-traditional policies, intervene for themselves or others, or even revalue their currency. Equities or commodities are valued by their intrinsic strength on an absolute basis, while foreign exchange is valued by the relative strength of one currency with respect to another. If the lower rates increase the number of homes or cars that are being purchased, this amounts to growth. Exploding bubbles, commodity shocks and major political events can create exceptions to the above scenario.
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This is an interest rate cycle, and it drives capital flows that are at the heart of the FX market. It all goes back to the incentive to invest. If Central Bankers want to slow down their economy, they look to raise rates. If they want to encourage more growth within an economy, they look to decrease rates. The first and most obvious impact is the incentive to invest. The second impact is what this does for capital expenditures. If rates decrease, the attractiveness of locking up a long-term loan at the new lower rate is much higher than it was previously.
The incentive to buy big-ticket items like homes, and cars is now higher. And when you buy a home or a car, the homebuilder or car maker has to turn around to pay for their materials and workers. If the lower rates increase the number of homes or cars that are being purchased, this amounts to growth. Homebuilders and car makers will eventually have to hire new workers to keep up with the demand; and as demand for workers increases, so will the wages that are needed to attract qualified candidates.
Prices can continue inflating, and if left unchecked — could bring hyperinflation. Imagine going to the store to buy a gallon of milk and seeing the price at 27 dollars. Then my mind would wander to other areas where costs might be increasing. If a gallon of milk is 27 dollars, then how much will that new car cost me? How much is milk going to cost tomorrow? So, Central Banks want a moderate rate of inflation.
Both Central Bankers and Forex Traders watch macroeconomic data prints with the goal of getting something out of them; but their objectives are slightly different. FX Traders are often interested in the price reaction of a data print. If CPI comes out higher than expected, then traders may be looking for long positions to move higher.
FX Traders can price in new data quickly, creating volatile price movements. Central Bankers want to watch the primary points of reference for an economy in an effort to make the correct decision as to where to move rates.
Inflation and employment are chief amongst these statistics, as these are two of the primary pressure points within an economy.
If unemployment is high, the economy will likely struggle. FX Traders will begin pricing this in with the probability of an eventual rate hike or cut by Central Bankers to factor this information in. As inflation CPI data prints are released in an economy, traders will act quickly to incorporate this new information in to prices.
Meanwhile, Central Bankers are watching cautiously to decide if they want to do anything at their next meeting. Increasing unemployment decreasing employment along with decreasing inflation are threats to an economy that will usually see Central Bankers investigate rate cuts. Decreasing unemployment increasing employment , and increasing inflation are signs of a growing economy, and this is when Central bankers will look at potential rate hikes.
But, Central Bankers and Forex traders alike are not happy to just sit around and wait for employment or inflation numbers to show changes within an economy. This has brought to light numerous additional data prints that traders and investors will look to in an effort to anticipate changes to inflation, unemployment and interest rates. Consumer statistics are extremely important in large economies like The United States, or Europe in which consumer activity has a heightened level of importance for the global economy.
In the article, The Lifeblood of the US Economy , we looked at the major data releases that include this information. The Euro can get extremely volatile around releases of Consumer Sentiment Numbers, and this is because consumer activity in established economies is often looked at as a precursor to inflation, employment, and growth. GDP, or Gross Domestic Product, is a direct expression of growth or contraction within an economy, and this can also be a huge precursor to price movements; especially if the announced rate of growth is far away from expectations.
Production numbers can be especially important in growing economies that are at a very industrialized stage of the growth process. The thought behind this statistic is that if producers are seeing growth, then that growth will eventually cycle through to consumers; after all, if someone wants to buy a good, it has to be produced in the first place, right? This makes trading on fundamentals in the FX market dangerous; because you could guess that GDP is going to come out better than expected, and you can trade it accordingly and still eat a stop.
You can be right, and still lose. In stocks, trading on fundamentals makes a lot of sense. You can grade company A versus company B in relevant markets. For this reason, many traders in the FX market incorporate or include Technical Analysis in their fundamental trade ideas. This can bring quite a bit of benefit to the trader in helping to determine trends or biases that may have been exhibited in a currency. Earlier in the article, we used the hypothetical example of the Bank of England increasing interest rates 25 basis points.
This increased demand will show higher prices. So, this is a fundamental theme — that is clear and apparent in the technical setup of the chart. If there is an up-trend, prices are moving higher for a reason, right? Traders can incorporate price action to see where these trends may be existing, and to what degree they might be traded. Begins by analyzing broad brush macroeconomic factors and aggregates of data working downwards narrowing and refining the search to include only those currency pairs that present a profit potential.
Conversely, this type of analysis starts with analyzing the currency pair working upwards to aggregate macroeconomic information. These factors are key drivers for currencies. If a country has a trade surplus this implies there is a high demand for its goods and services, consequently a greater demand for its currency thus driving up relative value. Similarly, higher relative interest rates lead to cash inflows, thus driving up the value of a currency. These have a significant impact on the valuation of commodities.
For example, a growth of international conflict may result in increased demand for nickel, which is used in armaments and ammunition manufacturing driving up prices. Fundamental analysis examines key drivers such as macro and micro economic data, and geopolitical events.
Fundamental analysis tells you what to trade, and technical analysis tell you when to trade it and complements fundamental analysis. Fundamental analysis can be fairly time consuming, and to this end, OANDA provides several high quality resources, including: Develop your trading strategy and learn to use trading tools for market analysis. Learn the skills necessary to open, modify and close trades, and the basic features of our trading platform.
Price Chart And Patterns. A trading strategy can offer benefits such as consistency of positive outcomes, and error minimization. Technical analysts track historical prices, and traded volumes in an attempt to identify market trends.
They rely on graphs and charts to plot this information and identify repeating patterns as a means to signal future buy and sell opportunities.
Introduction to Trading Analysis. Leveraged trading involves high risk since losses can exceed the original investment. A capital management plan is vital to the success and survival of traders with all levels of experience.
Learn risk management concepts to preserve your capital and minimize your risk exposure. Seek to understand how leveraged trading can generate larger profits or larger losses and how multiple open trades can increase your risk of an automatic margin closeout. Introduction to Capital Management. Execution speed numbers are based on the median round trip latency measurements from receipt to response for all Market Order and Trade Close requests executed between August 1st and November 30th on the OANDA V20 execution platform, excepting MT4 initiated orders.
For more information refer to our regulatory and financial compliance section. This is for general information purposes only - Examples shown are for illustrative purposes and may not reflect current prices from OANDA. It is not investment advice or an inducement to trade. Past history is not an indication of future performance.
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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.