Fundamental analysis for forex: what is it, how to understand, how to use | FxPro

What is fundamental analysis in forex?

Trading in the financial markets can be easy if you know what you are doing. Traders base their decisions on technical and fundamental analysis. Technical analysis in the foreign exchange market is pretty much similar to trading stocks and other asset classes. Fundamental analysis, however, differs when it comes to Forex trading. Stick with us to the and as we unwrap the nitty-gritty of Forex fundamental analysis.

What is Fundamental Analysis for Forex

Fundamental analysis is a method of trying to determine the market value of an asset. We use this technique in forex trading by analyzing the economic factors that affect the valuation and strength of a currency. It doesn’t consider historical price movements but rather takes advantage of certain data points to predict the value of a currency. 

You might have seen Forex markets run haywire whenever certain events happen in the world. It could be a terrorist attack or a major announcement by one of the world’s superpowers. Fundamental analysis helps you assess such events to make an informed trading decision. In other words, this type of trading looks into all economic, political, and social factors that affect the economy and uses that to predict the future movement of currency prices.

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What is the purpose of fundamental analysis?

Forex fundamental analysis is possibly the most important technique for assessing currency prices' future behaviour in forex trading. Its primary purpose is to show us the health status of an economy when engaging in forex trading. Traders use it to determine the value of one currency against the other. They must first understand why some events like an increase in jobs affect the economy of a country and issues like monetary policies that significantly influence the demand for a country’s currency. Forex fundamental analysis runs on the assumption that the long-term performance of any currency is directly pegged on the stability of that nation's economy. A better-shaped economy attracts investors and breeds a strong local currency.

Types of fundamental analysis

We can break down Forex fundamental analysis into two branches to understand it better.

  • Qualitative: This type of fundamental analysis focuses on decisions, events, and occurrences that affect a certain currency over a given period. 
  • Quantitative: On the other hand, quantitative fundamental trading relies purely on numbers such as inflation, employment rates, and similar factors to make trading decisions.

Applying Fundamental Analysis

The main tool for fundamental analysis when trading forex is the economic calendar. Always monitor it and make sure you have an understanding of all the upcoming releases. Don’t forget to check future events because forex prices tend to move in anticipation of future indicators. A fundamental forex trader will use reports such as inflation, employment data, gross domestic product, and central bank interest rates benchmarks when trading forex with this strategy. By understanding the data, this type of forex analysis can help guide you on how to trade the future movement of a currency.

Examples of Fundamental Analysis

Here are some examples and how they can guide you in decision making.

Indicator

Expectation

Effects

Decision

Interest Rates

Better than expected

Positive on currency valuation

Long

Gross Domestic Product

Better than expected

Positive on currency valuation

Long

Jobs Reports

Better than expected

Positive on currency valuation

Long

Consumer Price Inflation

Better than expected

Positive on currency valuation

Long

Trading Using Fundamental Analysis

Now that we understand the purpose of fundamental analysis let us jump to how you can incorporate it into your day-to-day trading. First, you need to analyze specific events that have the highest degree of influence on your currency of interest. Indicators such as central bank interest rate benchmarks, inflation, gross domestic product, and consumer report should never be left out.   

Here is a practical example. If you want to compare the strength of the dollar against the pound, you might look at the interest rates of the two countries. Let’s say the interest rate in the US is 0.25% while that in Britain is 0.05%. Which economy would you invest your funds in if you were looking to grow your money? The US, right? Every other investor thinks the same way. The country with the highest rate of return attracts more investors and, therefore, will have a stronger currency as its demand rises. With this picture in mind, you can use technical analysis to help you find more accurate trading points, having already known the long-term direction of GBPUSD from fundamental analysis.

Pros and Cons of Fundamental Analysis

Pros

In-depth Analysis

You’ve probably heard of the common statement that 95% of forex traders lose money within less than 90 days of trading. You can only avoid being in the losing gang if you conduct proper trading analysis before taking your trades. Fundamental analysis dissects deep issues of an economy, giving you a 360 degrees perspective of that country's currency. This can save you from nuking your funds by taking the wrong trades. No wonder good fundamental analysts are considered some of the best forex traders.

Long-term

Whether you’re an intra-day, swing, or position trader, understanding the long-term trend of the currencies you trade is vital for proper decision-making. Fundamental analysis considers various issues that influence the long-term stability of an economy and helps traders determine the dominant direction of the currency they are trading.

Cons

  1. Time Consuming

You must be ready to invest your time and dive into serious work if you choose to trade with this strategy. Remember you’re not just looking at one indicator and then deciding where a currency is going. Sometimes you will be required to listen to speeches such as the FED reports and find the meaning and impact of each key issue that the release was covering. 

  1. Complex

Some people might find forex fundamental analysis more complex than technical analysis. Monitoring data points as they change over time and simultaneously analyzing other macro and micro areas of the economy might be tricky for most casual investors. This strategy also uses a lot of assumptions and data interpretation which need personal experience, skill, and knowledge that some traders might lack.

A lot of experience and personal bias is needed to put together some of the qualitative factors, making it a subjective strategy.

  1. Limitations

Human emotions cannot be left out in trading. Greed, fear, and excitement form every part of the price tick that we see in the market. We call this the “herd mentality.” Forex fundamental analysis does not take that into account hence may not give you the best entry prices when trading forex.

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