Fundamental Analysis in FOREX Trading

It’s always been a huge debate about the methods for analyzing the price movement for the purpose of forecasting the value and price in financial markets. All the techniques applied for such analysis and forecasting methods falls in two main categories, known as Fundamental Analysis and Technical Analysis. As being a major part of Global Financial Markets same methods can be applied to analyze the price and value in Global Currency Market (also known as FOREX) but majority of the investors prefer to use technical approach over fundamental approach mainly because lack of understanding. This is why we decided to write about “Fundamental Analysis in FOREX Trading” today.

Before we begin discussion on our topic it is very important to understand,

1- What does it mean when someone talk about fundamentals?

2- What does fundamentals actually stands for?

Fundamentals:

All the basic information reported (either qualitative or quantitative) which shows or impact the current economic condition of the country, regional block or global situation as a whole is known as fundamental information.

Fundamentals in Foreign Exchange Markets:

Development in the different sectors of the economy impacts the currency market because currency market is one of the basic playgrounds of all economic activity, which is the reason why “Foreign Exchange Market” responds the fundamental information very quickly.

Fundamentals which impact the “Global Currency Markets” are very much connected, either they are as basic as interest rates, employment situation, GDP or the complicated ones like industrial production, International trade, or manufacturing.

Economic information itself is defiantly the main fundamental factor but political decisions and order of the nature are the other important factors which can impact the economic activity and considered as part of major fundamentals.

Fundamental Analysis of Foreign Exchange Markets:

Method for analyzing the economic information, political impacts – decisions and the impact of order of the nature for the purpose of forecasting market price is called fundamental analysis.

Such analysis helps understanding health and stability of the economy and work as a guideline for lawmakers and financial & economic mangers to maintain strong economic pace. On the other side understanding of fundamentals help investors and make it easier for them to make their investment decisions in both short to medium and strategic terms depending upon the category of investors (large funds, commercials and small speculators.

If the fundamentals are positive it helps to attracts investors while negative fundamentals carries the higher risks and force investors to look for investing opportunities elsewhere.

Working with the Fundamentals in Global Currency Markets:

For currency traders main purpose of fundamental analysis is to evaluate the fair price of the currency. In recent years the volume in currency markets is increased massively and majority of the volume is speculative.
As a short term effect of speculative volume currency exchange rates moves away from fair price, sometime they are overpriced and sometime under priced.
Fundamental analyst position themselves in an economic cycle (boom or bust) according to the fair value because fundamentalists believes that after such impulsive speculative swings, currencies eventually return to the fair price value.
I hope that in result of discussion above, being and independent retail trader you might have developed the basic understanding about the fundamentals and working of fundamental analysis. I believe that a question must be raised in your mind that:

How retail traders can implement the methodology based on Fundamental Analysis in their practical trading?

To answer this important question now I’ll mention few key points which are very important for every trader who want to implement fundamental based trading methodology.

Key notes to implement fundamental based trading methodology.

1- Create Bigger Picture:
Fundamental analysis is always about creating the bigger picture of the economy across the board – based on the facts which can affect the economy. To create the bigger picture in mind it is very important to follow the news releases, central bank comments, lending and borrowing statistics as well as you need to track the interest rates.
One also need to keep an eye on new technological innovations and financial products, as all of these factors can be an indicator for a healthy economic growth on a global scale and can keep you aware of the economic situation.
Few important factors which can help you to understand the bigger picture are following:

1.1- Understand Political Factors:
To create and develop a less risky portfolio, you also need to develop the understanding for the political climate (local and global) as well as all other attached variables (Seen & Hidden) which can help you identify the risk. If there are any situation of political instability and uncertainties in a nation or on global level, this can leave a negative impact on the growth. while on the other side if political situation is stable and political decisions gets appreciated by the business community and the public at large this will have a huge positive impact and can attract local and global investors because the growth is expected to expand.

1.2- Understand Global Economic Pace:
On the first stage of fundamental analysis you need to analyze the health and pace of the global economy because it can have a lot of impact on global currency market and can create volatility (we call it Delta factor or rate of change). If an economy is in good health and attracting global capital, than it becomes the main supportive force for its related currency’s value against others.

1.3- Identify Global Economic Cycle:
Develop an understanding about the global economic cycle, Identify the cycle in which global economy is moving. If you cannot keep a track for detailed characteristics of economic cycle at least you should know that which part of boom /bust cycle economy is in because boom /bust cycles are very strong and includes major events which force currency’s to move in the direction of economic cycle.

1.4- Understand the Lending Behavior:
During the bust phase of economic cycle lending standards are tightened by the financial institutions in the initial phase to stop the flow of funds to be used with a high degree of risk but when it matures – the rates are relaxed to speed up the recovery, while in the boom lending is relaxed – depending on the degree of growth.
If growth is becoming inflationary or economy is heating up then the rates get tightened. This is where it is very important for the currency traders to understand the ‘yield curve analytics which can give good predictive analysis of further lending rates behavior. Financial institution doesn’t want to lend money when economy is in bad shape and companies are on the risk of bankruptcy, they only love to do so when economy is booming and everyone is making great profits, because this help generate  better income for them.
When economic cycle is in to the bust phase reserve currencies always appreciate against the currency of other nation, while during the economic boom, reserve currencies depreciates, because economic booms are backed by lending.
When you understand the bigger picture and are in a position of drawing up an ‘Investment Landscape’ than it is very easy for you to place your trades & calculate your stakes in harmony with the main economic activity driven trends, which can lead you to greater success in generating above average returns on your invested portfolio or single investment.

2- Identify the Market Players:
You need to understand what kind of market players drive the price trends in global currency markets. Identification of market
Players can help you understand the nature of the market cycle.
There are two type of market players:
1- Speculators
2- Commercials
If market price is driven by monetary expansion than it is based on easy money and speculative interest, but if it is driven by innovation and productivity increase in technological or social sectors than it is a result of genuine economic activities.

2.1- Speculators and Speculation?
Strong fundamental dynamics can be utilized by speculators to move the prices in one direction, such speculative moves are known as speculation and can create bubbles, because bubbles only grow when there is a reasonable profit opportunity. Ultimately these bubbles tend to bursts sometimes very quick and suddenly which can be very destructive for the market price.
In a speculative bubble it is better to create an understanding about the cause of bubble and wait for its termination before entering a trade. In such condition you may have to wait long to find an entry, as it may take time before the bubble bursts and correction starts. For retail traders it is not easy to wait till beginning of correction because one cannot choose to ignore the market’s emotional behavior. That is why there is nothing wrong in participating the opportunities when speculative moves is in its early stage.
Fundamental analysis helps you explore the causes of economic events so you can avoid jumping on the train of speculation at the height of the bubble, and can reverse direction of your investment strategy with greater agility – when fundamental factors start indicating a change in economic environment. You only need to follow the trend as long as the fundamental factors supports.

3- Implementation of Fundamental Analysis:
Second stage of fundamental analysis is implementation stage, deciding which currency to buy or sell; you already learned that you need to examine the fundamental health of the economy. Once you are through that process, next you will evaluate the attitude of the main drivers of the global currency market towards the fundamentals.

3.1- Entering in a Trade:
You can buy the currency when economic policies are reliable and healthy, and the market players consider them positive, only cautious is to beware of bubbles.
If economic policies shows weakness in the economy and market players also consider the same than you can sell the currency.
If economic policies and market players reaction doesn’t match with each other than there is a strong chance of getting struck into a speculative bubble, in such a case one should stay away from the market.

Final Thoughts / Conclusion:

In global currency markets fundamental analysis are very useful to exploit long-term price trends, also they help avoiding speculative bubbles when they burst or about to burst. 
Fundamental analysis are not limited only to examine the well-being of an economy, but provides an opportunity to financial institutions, academics or politicians /economic and financial managers, to decide the best course for a nation’s economy.
And, It provides valuable tool in crafting investment models suited to individuals and large investors for making decisions to become “Risk Averse”, according to the strategy.