Fundamental analysis is a strategy to forecast the intrinsic value of an investment. Fundamental analysis takes its roots from the hypothesis that the market price of an asset has a tendency to move towards its “real value” or “intrinsic value”.
Fundamental analysis in Forex predicts the price value of a currency and its market trend through analysis of Government policy, economic forces, and social factors within. Forex Traders estimate country’s economic situation by examining macroeconomic indicators such as:
- Gross Domestic Product (GDP)
- Interest Rates
- Employment Index
- Consumer Price Index (Inflation) and Spending Index
- Retail Trade and Consumer Confidence
- Government Fiscal and Monetary Policy
- Balance of Trade Surplus or Deficit
Fundamental Analysis Benefits
– Identifying the intrinsic value of an investment
– Determining other long-term investment opportunities
Fundamental Analysis Disadvantages
– Too many macroeconomic indicators can seem quite complicated to new trader
– Macroeconomic indicators are statistics that point current state of the economy of a specific country depending on a particular area of the economy (industry, labor market, trade, etc.). They are disclosed on a regular basis on specific times by governmental agencies and private institutions. Beacon FX provides Economic Calendar for the dates of significant fundamental events and announcements. Economic Calendar indicators are very useful tools for any trader.
Announcement of Interest Rates
Interest rates represent one of the major roles in affecting currency prices in the foreign exchange market. Central banks are the most influential institutions in this setting the interest rates. Interest rates usually determine the flow of investments. Because currencies is a good source of evaluating a country’s economy, variations in the rates of interest affect the relative worth of currencies in relation to each other. If central banks change rates of interest, this causes the currencies to fluctuate and market gets volatile. In Forex trading, proper use of speculation by central banks’ actions can increase trader’s chance for successful trading.
Gross Domestic Product (GDP)
The GDP is general measure of a country’s economic state as it represents the total market value of all goods and services produced in a specific country during a fiscal year. Due to the fact that the GDP itself is often considered a lagging indicator, Forex traders pay attention to two reports which are announced in the months before the final GDP figures: the preliminary report and the advance report. Considerable comparison between these reports can cause significant volatility.
Consumer Price Index
The Consumer Price Index (CPI) perhaps is the most critical indicator of inflation in a country. It reflects changes in retail prices levels for the basic consumer basket. Inflation is related directly to the purchasing power of domestic currency and affects its position on the international markets. If the economy is being developed in normal conditions, the increase in CPI as a rule leads to an increase in basic interest rates. In its turn, this will lead to an increase in the competitiveness of a domestic currency.
Employment indicators reflect the overall health of an economy or a business cycle. To better understand how a specific economy is doing, it is crucial to be aware how many jobs are being created or destructed along with the percentage of the work force is actually employed, and how many new people claim to be unemployment. To measure inflation it is crucial to examine the speed at which wages are growing.
The retail sales indicator is published monthly and it appears to be an important one to the currency trader as it represents the overall strength of consumer spending and the retail stores’ success. The report can be especially useful because it is a timely indicator of general consumer spending patterns that is adjusted for seasonal variables. It is usually used to forecast the performance of other significant lagging indicators and also to evaluate the immediate state of an economy.
Balance of Payments
The Balance of Payments is the ratio of the number of payments received from abroad and the number payments leaving abroad. Generally speaking, it reflects the total number of foreign trade transactions, trade balance, and balance between exports and imports, as well as transfer payments. If the number of coming payments exceeds the number of payments leaving to other countries and international institutions, then the balance of payments turns out positive. The surplus in balance of payments is a favorable factor for growth of the national currency.
Government Fiscal and Monetary policy
Stabilization of the economy (e.g., control of inflation, full employment, and an equitable balance of payments) is one of the major goals Governments strive to achieve through formulation and manipulation of fiscal and monetary policies. Fiscal policy is related to Government’s taxes and expenditures; monetary policy is linked to financial markets and the supply of money, credit, and other financial assets.
A large variety of economic indicators along with reports of a private sector should be considered and evaluated in order to determine the fundamental principles of a Forex industry. However, one indicator or a figure can’t speak alone; these should be taken in combination with other economical indicators as a whole picture in order to determine economic condition of a nation.
Technical analysis is a method for forecasting the direction of prices using the historical market data, primarily price, volume and open interest.
Currency traders use technical analysis information (e.g. previous prices and trading volumes) as well as mathematical indicators to decide on their trading strategies. Such information is usually presented in a form of graphical chart which gets updated in real time which is interpreted for determining when to buy and when to sell a specific instrument.
Modern technical analysis takes its roots from the ideas of Charles Dow who was the first editor of the Wall Street Journal. It is forms three main premises:
Prices move in trends which can be traced and turned into opportunities for profit.
The price is a comprehensive reflection of all market forces. At any given time, all market information and forces are reflected in prices.
Price movements are as a rule historically repetitive.
Advantages of Technical Analysis
Technical analysis requires less data than fundamental analysis. Technical trader can acquire all the needed information from price and volume.
With technical analysis the question of timing to enter a trade is easier to address since it is focused on identifying trend reversal.
Limitations of Technical Analysis
Technical analysis may become a self-fulfilling prophecy. If too many traders would use the same tools and follow the same principles, they together would shift the demand and supply; which would lead to the prices moved in the forecasted direction.
Technical and/or Fundamental Analysis
Technical Analysis is by far one of the most important tools for forecasting the behavior of a financial market. It is proved as an effective tool for investors and traders, and lately becoming widely accepted among the market participants. When utilized in combination with fundamental analysis, technical analysis provides much more complete judgment which inevitably leads to more successful trades.
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