Fundamental analysis is a method that attempts to predict the intrinsic value of an investment. In general, it’s based on the theory that the market price of an asset tends to move towards its ‘real value’ or ‘intrinsic value’.
In the Forex markets, fundamentals are driven mainly by economic data from the country or monetary union related to the currencies involved.
For example, a company’s shares may arguably have an intrinsic value based on its current or expected earnings as a corporation. The US Dollar, however, has had no intrinsic value since the end of the Gold standard in the 1970’s. (The same can be said for all fiat currencies in the world today.)
Rather, since every currency pair involves two individual currencies, the main influences of a currency pair’s price is simply the relation between the interbank market’s expectations toward each of its individual currencies’ economic output as well as the country or monetary union’s expected central bank policies (especially interest rate decisions).
It’s important for currency traders to become familiar with the most important economic data announcements and central bank decisions related to the currency pair:
Interest Rates Announcement
Gross Domestic Product (GDP)
Consumer Price Index (Inflation) and Spending Indicators
Retail Trade and Consumer Confidence
Balance of Trade Surplus or Deficit
Government Fiscal and Monetary Policy
The next generation xStation platform includes an integrated Economic Calendar in the trading software. There’s no longer a need to check for these announcements on web sites when it’s only a click away while you’re trading.
It’s also important to keep in mind that the market is not the answer. The market is the expectation.
Like the old adage by stock traders, “Buy on Rumour, Sell on News,” market prices are not about a present day reality. They’re about the market’s expectation of the future.
Example: The EUR/USD has been falling precipitously as the European Union suffers from a horrible state of affairs, affirmed by news reports worldwide… but you firmly believe that the European Union, for some reason due to your own in-depth analysis, will miraculously turn things around in the near future.
a. Buy EUR/USD
b. Short Sell EUR/USD
A typical losing trader would choose “b” and Short Sell the EUR/USD to follow the current trend because he or she is influenced by the media’s sensationalist reports of the present day’s doomed EU situation which has already been priced into the market. (When something is widely reported in the news, the professionals in the market already know about it, let alone your taxi driver and your grandmother.)
However, in this hypothetical scenario, you are a professional trader who has discovered convincing evidence that the EU has a trick up its sleeve to turn things around.
In such a scenario, your correct trade would be “a” – buy (go long on) EUR/USD because you expect it to go up in the future due to improved economics.
If, in this hypothetical reality, you were correct in your view, then the EUR/USD will begin to rise as other market participants become aware of the expectation of improvements in the EU.
This example is not intended to imply that the European Union will, in fact, fix all of its problems. The purpose of this example is to illustrate the importance of trading your own expectation (especially if you have reason to believe your expectation goes against “commonly accepted” beliefs) rather than following the emotional way.
Fundamental Analysis Benefits
While beginners tend to look at “Fundamental Analysis vs Technical Analysis” as opposing forces, professional traders understand that the two are intertwined in a single reality.
Ignoring one or the other is akin to a doctor who only believes in viruses but refuses to believe in the existence of infections. Would you want to be his patient?
Your trading account would prefer that you understand the importance of using fundamental analysis as part of the picture… because the interbank market trades on it.
Identifying Short-Term Trading Opportunities
Whether you’re a day trader or a scalper, it makes sense to look at the short-term picture as well as the bigger picture.
If, for instance, you hold a long-term view that the US Dollar is doomed to death-by-inflation, don’t let this opinion cloud your judgement. Continue to keep an open mind and look for short-term trading opportunities, even if they might contradict your long-term opinions.
After all, every trader who followed the herd and believed in the US Dollar’s doom suffered horrendous losses in 2014-2015. Being right (in the long term, especially) means nothing in the short-term.
Making money in the meantime will support your lifestyle. Losing money from stubborn opinions will only add losers to the market.
Always analyse the market with as much objectivity as you can manage. At the very least, you may discover some opportunities missed by the crowd. That’s when the market pays you.