Foreign exchange traders rely on both fundamental and technical methods of analysis to make trading decisions. The use of technical analysis is alike in foreign exchange and the stock market. The charts are the objects of analysis, and the prices reflect all trading news.
However, countries, unlike companies, have no balance sheets. Thus the question: how can you conduct fundamental analysis on a country’s currency?
This article aims to answer that question by reviewing some of the fundamental factors that play a role in the movement of a country’s currency.
Factors that Influence a Currency’s Movement
Fundamental analysis involves the evaluation of the intrinsic value of an investment. Its application in the forex trade involves evaluating economic conditions that affect the value of a particular currency. Some of the fundamental factors that influence the movement of a country’s currency include:
The Gross Domestic Product (GDP) of a Country
The GDP of a country is the broadest measure of its economy. It shows the market value of all the services and goods produced in a country in a given year. Most traders rely on the advance and preliminary reports issued before the final GDP is announced because the actual GDP figure is often a lagging indicator.
Economic indicator reports are issued by the government detailing a country’s financial performance in a given duration. Traders use economic indicators to measure the health of a country’s economy. Before making a trading decision based on economic indicators, it is essential to note that many policies and factors affect a country’s financial performance and consider them.
These reports indicate whether the economy of a country is improving or declining. The reports such as unemployment numbers and housing stats are often not given much coverage. However, in forex trading, each indicator helps indicate the economic health of the country.
Industrial production reports indicate the economic outcomes of mines, factories and utilities of a country. It also shows the degree to which each factory’s capacity is being utilized. A country that has a production increase at its maximum or near-maximum capacity utilization is considered ideal.
The retail sales report assesses the immediate direction of a country’s economy and predicts the performance of lagging indicators. This report evaluates the receipts of all retail stores in a country from a diverse sample of stores across the country. Traders focus on getting these reports before any revisions are done because modifications cause significant volatility.
Consumer Price Index
This is a measure of the change in the prices of consumer goods across various categories. This report is evaluated against a country’s export to tell whether the country is making losses on its product and services or not. You should monitor exports often because their prices often change according to the country’s currency, whether weak or strong.
Other significant indicators used in the fundamental analysis include producer price index, purchase manager index, employment cost index, durable goods report and housing statistics. These reports are valuable indicators of a country’s economic health and can benefit a trader if appropriately utilized.
Tips for Analyzing Fundamentals in Forex Trade
Economic indicators gauge the financial status of a country. Hence changes in the reports released directly affect the volume and price of a country’s currency. In addition, technical factors and third-party reports could also affect a country’s currency valuation. Hence, when conducting fundamental analysis in the forex market, it is essential to:
Keep an economic calendar with a list of indicators due to be released because markets often move in anticipation of a particular report or indicator.
Be informed about all indicators that could affect the market at any given time, e.g., inflation. When the US dollar weakens, traders often watch out for inflation as such an indicator can influence volume movements and prices in the market.
Sometimes there is a difference between expectations and actual results of released reports. Hence, it’s essential to pay attention to whether expected results are achieved and be aware of any justification for the difference as it can drastically affect the forex market.
When analyzing forex fundamentals, take a bit of time before reacting because when numbers are released, they are often changed, and these revisions cause drastic changes in the market.
Many economic indicators can be used to evaluate forex fundamentals. When conducting fundamental analysis, it’s essential to look at the numbers and take time to consider what they mean, as the interpretation could have a significant impact on the country’s currency valuation.