August 1, 2013
Fundamental Analysis & Forex Markets
Yesterday I talked a lot about technical analysis, so today I thought it was worth balancing this up with an article about fundamental analysis.
This article was supplied to us by Patrik Fonce from Quantshare. I hope you find it useful.
The forex market is the big daddy of all the financial markets that are functional globally. And there is not an iota of exaggeration involved in the preceding statement. Given the highly leveraged nature of trades, 24X5 market hours and high liquidity, no wonders the forex market has the highest turnover across the financial markets and asset classes. Post Bretton Woods saw a religious increase in the activities and turnover of the forex markets, reaching an average daily turnover in excess of US $4 trillion in 2010 as per the reports of Bank for International Settlements.
The forex market is the darling of traders because of the highly lucrative opportunities that it provides. But then, for small trader without many resources at their disposal, it can turn out to be a nightmare with large heartbreaking losses. What one needs to understand is, getting in the arena without doing proper homework is only going to give some bruises in return. Although a proper understanding of the concepts, factors and analysis can take some time but the basic fundamentals are no rocket science. The analytical methods that traders use are technical and fundamental, similar to that of equity markets. While technical analysis is more about charts and price histories, fundamental analysis is about the macro views. Most of the traders rely on technical analysis for day trading and short term trades. But fundamental analysis is equally important. It gives you the broader picture of the market movements and trends.
Enough of foreplay there!!! Let’s come to the point.
Major factors that affect the fundamentals of the forex market are discussed below for your understanding and can be exploited for a better trading strategy if used in the right way.
The most basic thing you need to start with is an economic calendar and you need to keep it handy in order to have a quick and regular eye on the important events. An economic calendar is basically a collection of dates on which important economic data and policy updates are made public.
There are a number of major economic indicators that affect a currency. Some of these have direct and major impact while others are indirect and minor factors. The most important are:
i. Interest Rates: Interest rates have positive effect on a currency. Higher interest rates lead to strengthening of the currency as higher interest rates attract investments from abroad and push the demand for the currency up.
ii. GDP: A higher GDP data shows the strength in the economy. This in turn leads to an expected interest rate hike which in turn is good for the currency.
iii. Trade Balance: A positive trade balance or low trade deficit leads to a higher demand for the concerned currency against the other currencies thus increasing its value. USD being a global currency is not much affected by this factor as an exception.
iv. Employment: Lower unemployment indicates positive growth in the economy which is good for the currency. v. Inflation: This indicator is to be specially watched out because higher inflation rate leads to hike in interest rates to check the former. This strengthens the currency because of the increased demand in foreign markets from where investments flow in to cash the high interest rates.
vi. Manufacturing output, retail sales, housing etc.: An increase in all of such factors means growing demand which is a sign of healthy economy. This is a great sign for the currency.
Beside these demand side factors, there are some supply side factors as well.
Easy Money: Higher supply of a currency in the markets weakens it. Some of the ways of supply increase are by bond buying by central bank, quantitative easing, policy rate cuts etc. This can be best explained by the effect on dollar after Fed Reserve’s recent policy updates proposing a tapering in quantitative easing which led to concerns over USD liquidity in future. This shot the bond yields up, even though the interest rates are quite low, attracting a lot of funds from across the globe, thus pushing up the USD demand.
Also the same set of indicators of the opposite currency also needs to be watched. A weakness in the second currency in a currency pair implies a strengthening first currency. These are some of the most important fundamental indicators. There are also a lot of minor factors that affect the exchange rates in the short run, for example news related triggers.
For traders a sound knowledge of these indicators and the future expected changes in these indicators is very important as it can help in identifying an upcoming trend and making the most out of it. Concluding things here, I would suggest you to regularly track the economic calendar and news updates that affect the fundamentals of currencies in particular in order to make a successful forex trading strategy. Remember that the forex market is considered the most efficient of the financial markets and hence you need to be quick in acting on the triggers before their effects fade out.
Article written by Patrik Fonce from quantshare.com.