Forex Fundamental analysis is one of the two major methods that Forex traders use to help them formulate their investment strategies.
Forex Fundamental analysis essentially relies on studying the underlying macro elements that affect the economy of a country.
It allows us to have an overall picture of the currency movements due to pressure from factors like economic, environmental, political and other macro factors that can affect the basic laws of supply and demand.
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To utilize fundamental analysis strategies, traders must a grasp on how these Macro economic factors are intertwined with the economy.
Data concerning unemployment, interest rates, inflation rate, GDP and even political ideology can affect how the market will value a country’s currency.
Thus, Forex traders will keep an eye on key speeches made by the country political and banking sector leaders, announcement and figures released by the relevant government agencies as well as those from key personalities from the private sector.
A Simple Supply and Demand Market
By relying on the underlying principle of demand and supply that when prices goes up, demand will fall and supply will increase and vice versa, fundamentalists will look for fluctuations in prices through the key economic indicators like the consumer price index (CPI), Interest rates or Gross Domestic Product (GDP).
This method of analysis, although unable to provide exact prices, is extremely effective in forecasting the conditions of the economy. Nevertheless, forecasting is both an art as well as a science. This is because there are so many factors that can affect a country and its currency.
From the distinct and obvious to the erratic, fundamental analysts try to make sense of all the chaos in the Forex market by creating models that can help explain the chaotic behavior of currency fluctuations.
These economic models are based on key market drivers that drive the value of a country’s currency.
For example, interest rates movements have a profound effect on the strength of a currency.
Interest rate is taken as a measure of the cost of borrowing.
Thus, with higher interest rates, this will lead to more foreign investments as investors tried to capitalize on the rising interest rate.
Ultimately, this will result in more demand for that country’s currency and hence pushing up its value. On the other hand, rising interest rates in another competing country can also affect the value of a country’s currency.
For example, higher interest rates in the European communities may cause the value of the US dollar to drop as US investors are prompted to sell off their US dollars holdings to invest in European Bonds.
Macro-Economic Changes to Help Predict Movements
In summary, with the use of fundamental analysis, Forex traders are able to discern if prices in the Forex market is undervalued or overvalued. Even though one cannot arrive at an exact value of the prices, one can still obtain a fair estimation of the intrinsic value of the prices through fundamental analysis.
Thus, if the conclusion is that the intrinsic value of a currency is higher than the current market price, the trader will purchase the currency. Conversely, if the intrinsic value of the currency is below the current market price, a trader will sell the currency.
Because fundamental analysis looks at the broader picture of the Forex market, to formulate a proper trading strategy, Forex traders also have to rely on Technical analysis in order to obtain a more detailed look at the fluctuation of a currency.