How Fundamentals are important in Forex?
Fundamental Analysis is a process of analyzing a security in order to determine its fair value (also known as intrinsic value), by evaluating relevant economic, financial, non-financial and other quantitative and qualitative factors.
Fundamental trading is a method by which a trader focuses on company-specific events to determine which stock to buy and when to buy it. Trading on fundamentals is more closely associated with the buy-and-hold strategy of investing than with short-term trading. There are, however, specific instances in which trading on fundamentals can generate some nice profits in a short period.
As the largest financial marketplace, forex is affected by an incredibly diverse amount of factors. These market fundamentals are the key pieces to determining when a currency is going to rise in value and when it's going to fall. Trading on the fundamentals – also referred to as trading the news, is the study of news events and economic statistics to determine trading opportunities. These traders pay close attention to changes in economic indicators such as interest rates, employment rates, and inflation. By assessing the relative trend of these data points, a trader is analyzing the relative health of the country’s economy and whether to trade the future movement of their currency.
There are times in the market cycle when the true value of a currency pair is at variance with the market value of the currency pair. The job of the fundamental analyst is to look at a currency using certain factors of evaluation, compare its valuation with another currency, and determine if the present value is the true value of the pairing, or if the value of one currency against another is undervalued or overvalued. If a currency is undervalued, then the trader’s response to the fundamental analysis is to assume a long position on the undervalued. Similarly, if the fundamental analyst sees a currency as overvalued, a short position will be assumed so as to benefit from a future downward move towards true valuation.
The relative importance of these releases may change: Business Sentiment Surveys, Consumer Confidence Surveys, Gross Domestic Product (GDP), Industrial Production, Inflation (consumer price or producer price), Interest Rate Decision, Manufacturing Sector Surveys, Retail Sales, Trade Balance, Employment / Unemployment (Non-Farm Payrolls).
Interest rate policy is the biggest key driver of currency prices and typically a forex fundamental analysis strategy for currency traders. If an economy is strong or weak this will be reflected in that country's interest rate policy, and ultimately, the strength or weakness of the currency. Fundamentally, if a country or currency region raises its interest rates and has a strong monetary policy, the currency of that country will strengthen. Also if a country or currency region is lowering interest rates that individual currency could be weak.
Since economic indicators gauge a country's economic state, changes in the conditions reported will therefore directly affect the price and volume of a country's currency. There are many economic indicators, and even more private reports, that can be used to evaluate forex fundamentals. It's important to take the time to not only look at the numbers but also understand what they mean and how they affect a nation's economy. When properly used, these indicators can be an invaluable resource for any currency trader.
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