Basics of Fundamental Analysis
The fundamental analysis considers the two economies that represent the currencies in a currency pair. However, fundamental factors are not only economic ones. Political events, like elections, are part of the fundamental analysis as well. Usually, anything that is not technically related, it is considered as a fundamental reason why markets are moving, like wars, etc. Predicting such events is a hard thing to do, if not impossible. Even though some elections outcome may be interpreted ahead of their release due to other factors, the way to treat fundamental analysis is to know where to take your information from and to be aware of what is the information that will move the market in the period ahead. In other words, being proactive rather than reactive works all the time. This, together with technical analysis, is the recipe for successful trading.
What Makes Fundamental Analysis
The biggest chunk of fundamental analysis is formed by the economic news that is released on a constant and scheduled basis. The economic calendar is a must for every trader as this news are the salt and pepper for the Forex trading. It is being said that technical analysis is giving the direction the market is going to go, while the fundamental analysis is offering the reason for such a move to happen. This is one hundred percent true. Let me give you an example. Every first Friday of each trading month, the jobs data in the United States, the Non-Farm Payrolls (NFP) indicator is released. This makes it extremely unlikely for the overall dollar pairs to move during that week until the NFP numbers are being released. Therefore, if you’re looking for a big move to come due to your technical analysis, and you’re in the NFP week, chances are the move won’t start until Friday. And just like that, fundamental analysis plays an important role in the way markets move and the way profits are being made, if any, in a trading account.
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The economic calendar shows the news and high-impact events that will have a say in how the market will move. They are organized based on the currencies that are being impacted, and traders will know where is the risk of market making wild moves. As a rule of thumb, there is nothing more important in currency trading than correctly positioning for the next central bank’s move. This is all that matters for traders: what the central bank is going to do with the interest rate and with the overall monetary policy next time its members meet. Everyone wants to own a currency that pays a higher interest rate, and this is the main driver in the Forex market. Any other economic releases that are coming between two central bank’s meetings are only viewed as how they are influencing the future decision regarding interest rates. Therefore, look for central bank meetings for the currencies you interested to trade, as well as member’s speeches and other news that may influence the future monetary policy. You’ll find out the market will move aggressively when these events are happening. As a short mentioning, in the order of their importance, the economic news part of the economic calendar is central banks meetings and interest rate decisions, inflation data, jobs data, PMI’s (Purchasing Managers Index), GDP (Gross Domestic Product), Retail Sales, etc.
Political events have a lot of influence in the way markets move. Especially when these are happening in countries that have economies ranked as the biggest in the world. 2016 brought two such events that are worth mentioning here: the U.K.’s referendum vote and the United States Presidential election. Due to the uncertainty that surrounded both events, markets didn’t really move until the outcome was known. And after that, based on the outcome, violent moves hit. The reason for that is that traders are always looking ahead, trying to interpret what the impact of an economy and on its currency, will be. For example, right after Mr. Trump was obvious that is going to win the White House, the dollar started to appreciate across the board. The reason for that was that traders looked closer at Mr. Trump’s agenda and at the promises he made during the election campaign and interpret the possible implications for the U.S. dollar. This, together with the classical supply and demand balance, made the dollar move across the Forex dashboard. The same was valid in the case of the Brexit vote when the United Kingdom decided to leave the European Union.
Who Trades Mostly on Fundamental Reasons
Big institutional players like hedge funds and other investment vehicles are using mostly fundamental analysis for their trades. This is to be viewed as the main reason for being in a trade, as the actual execution is based on technical factors. Let me give you an example. Such a position is being built in time, it is not a “one time pushing the button” thing. In this case, fundamental analysis is part of the so-called macro-decision to invest in a financial product. It may be that these investment managers are bearish on an economy, or on the way monetary policy is applied in an economy. Therefore, they want to take a bearish bet on that economy’s currency. To do that, they will sell the currency. The next thing to do is to find what is the perfect currency to sell it against. In doing that, a suitable currency pair is identified. This is fundamental analysis to the extremes and the macro-global picture is key here. However, as mentioned earlier, the execution is technical. What these traders are doing is called scaling into a position. No one goes and makes a big short bet on a currency pair or on a currency in general by throwing the whole amount in the market at one time. The scaling process calls for adding to a position multiple times to build the right and proper average. Trend indicators are being used, divergences, other local fundamental factors (like changes in monetary policy, etc.), and much more. Now that we’ve talked the basis of both technical and fundamental analysis, it is worth mentioning here that technical analysis is mostly appealing to retail traders, while fundamental analysis is for the big players. Rarely retail traders understand fundamental factors that drive prices in an economy, and this is a big handicap. On the other hand, if one is looking at the size of the retail trading in the overall Forex market transactions (less than five percent of all daily transactions are belonging to the retail traders), then the conclusion is that fundamental analysis is more important than the technical picture. Again, this is true to some extent. The correct way is to look at what may move markets and to act technically. This is what big players are doing as well, only on a bigger scale.
Recommended Further Readings
- Financial Products to Trade
– Different categories of financial products that a Forex Broker is offering for the retail clients, starting with the classical currency pairs, and continuing with commodities, CFD’s, indexes, etc.
- Forex Trading Sessions and Their Importance
– Explaining the differences between the three Forex trading sessions, what are their importance, ranking, etc.
- Forex Brokers Types – ECN or STP?
– What is ECN, STP, how d- brokers deal with client’s orders, advantages, and disadvantages of the tw- types.
- What Makes a Good Forex Broker?
– Things to consider when deciding what broker to trade with. What are the factors that weigh the most in the decision-making process?
- “Neural network techniques for financial performance prediction: integrating fundamental and technical analysis.” Lam, Monica. Decision support systems 37, no. 4 (2004): 567-581.
- “Stock trading using RSPOP: A novel rough set-based neuro-fuzzy approach.” Ang, Kai Keng, and Chai Quek. IEEE Transactions on Neural Networks 17, no. 5 (2006): 1301