Fundamental analysis in forex trading

Fundamental analysis

Fundamental analysis allows us to anticipate market developments over the long term, but also in the short term during major economic announcements. Some economic news announcements result in very rapid movements of currency pairs.

The study of macroeconomic data doesn't provide forex traders a specific indication of ideal points of entry or exit, unlike technical analysis, but it can be help these traders predict the direction of a trend. Moreover, the markets anticipate events and exchange rates are often a bit off from their actual values.

The economic health of a country depends on a number of factors such as its bank interest rate, unemployment rate, inflation rate and fiscal policy. Other data related to politics also has an effect on the market because it affects the level of confidence in a country's government.

Sometimes, governments intervene to increase or decrease the value of their currency, while doing nothing to stop rumours of such intervention; central banks can also have an impact on the forex market (usually temporarily) when they buy or sell currencies in order to limit inflation.

-> How monetary policy affects your investments
-> How do fundamentals affect prices on the forex?
-> The euro (EUR) - Main characteristics
-> The US dollar (USD) - Main features
-> The British pound (GBP) - Main features

The economic calendar

A smart forex trader regularly consults the economic report calendar in order to know exactly when major economic data and reports are going to be published. However, it is common for financial markets to react in anticipation of these announcements; in this case, it's not the actual announcement that will have an impact, but the DIFFERENCE between the expected figure and the actual figure that is released.

->Economic report calendar

Which news announcements are best for trading?

A large amount of economic news is published daily, so it is not possible to monitor all of the indicators; you should only focus on those indicators that have a significant impact on the markets. Keep yourself informed of the major indicators, such as GDP, inflation (using the producer price index or the consumer price index), the number of jobs created in the U.S. (non-farm payrolls), interest rate announcements, etc., as these are the indicators that move the markets.

Each country has its own indicators that affect the value of the national currency. However, a trader should first examine what is going on with the US dollar, since US economic news often has a strong influence on the rates of other currencies.

-> The main US economic indicators
-> Long-term TIC transactions
-> The main economic indicators of the European Union and the euro (EUR)
-> The major economic indicators for the United Kingdom and the British pound (GBP)
-> Fundamental factors that affect the currency markets in the short term

How do I interpret these economic indicators?

Indicators should be compared with past data; they play a fundamental role in the financial markets. but it is the element of surprise associated with their announcement that impacts the markets, most published results are different from the forecast, the more 'short-term impact on the price of currency will be strong!

Economic indicator historical data

How do I trade the news?

A market that is quiet before an economic news report or figure is released can be a sign that high volatility is about to appear. It is therefore better to wait a few minutes after the news is released before positioning yourself on the market.

Trading using the Non-Farm Payrolls
-> The central banks' interest rates
Interest rates and inflation: their impact on currencies
Deflation - definition and effect on the economy
The other economic indicators that impact the value of a currency

How do economists make their exchange rate forecasts?

In this series of articles, we examine the various fundamental analysis models that are used by analysts of major investment banks to predict currency price changes. These models can be useful for traders who want to increase their knowledge of fundamental analysis as it applies to the forex market. There are currently seven main exchange rate forecasting models:

Balance of payments theory (BOP)
The purchasing power parity model (PPP)
Interest rate parity (IRP)
The monetary exchange rate model
The interest rate differential model
The asset market model
The currency substitution model

Each of these models has its advantages and disadvantages in analysing and predicting currency price behaviour. In some cases, they have fallen into disuse because economists consider that there are more appropriate models or that the premises on which they were developed no longer have any validity. It is also important to understand that these models are used to study the evolution of the foreign exchange market in the long term and are therefore not applicable to the forecasting of short-term price behaviour, in which case it is recommended to use other tools such as technical analysis and fundamental analysis focusing on economic indicators that can have an impact in the short and medium term (for example, NFP figures, which generally cause a strong and immediate reaction in the financial markets).

Thus, the usefulness of these models stems from the fact that they provide a general understanding of market movements produced over periods of several months or even years, since they are based on macroeconomic factors that can affect exchange rate flows between countries.

For the long-term investor, these models can be used as a tool to determine where the market is headed and where it will go in the coming months and years, while for the trader focused on the shorter time frame, they can be used to determine the possible general market trend of the future.

The risks involved

Trading during news announcements requires lots of control and experience. The high level of volatility offers the opportunity to make quick profits, but you can also lose money fast. Use low leverage to trade the news.

It is very common for brokers to change their trading conditions during these news announcements. Before you trade during news, make sure that your broker doesn't subject its traders to slippage, spreads which widen considerably, resulting in your stop loss being hit even if the price doesn't hit it. When the news is released, the broker may also increase the minimum distance required to place a buy stop or a sell stop position as well as place a take profit or a stop loss. The possibility of placing an order may also be temporarily interrupted.

Generally speaking, no dealing desk, ECN and STP brokers are strongly recommended for trading the news.