Fundamental analysis is the study of macro events and how these events guide the direction of a currency pair or any security. In the currency markets, fundamental analysis focuses on economic and monetary policy events that will help investors attain a value for a currency pair. Some investors also believe that political events are incorporated into fundamental analysis as geo-political risks can alter the value of a currency. In a nutshell, nearly every piece of news that is not considered price analysis, can be considered a function of fundamental analysis.
The Goal of Fundamental Analysis
The goal of a fundamental analyst is to use a macro view to determine the future direction of a currency pair. Many believe that the interest rate differentials of each country are the driving force behind the movements of a currency pair, which means that if you can evaluate the interest rate differential you can attain a value for a currency pair.
The way most traders analyze interest rates is based on their view of growth, inflation, and job creation. Each country or monetary union has a central bank that dictates monetary policy. The policy is geared toward providing growth and job creating with a mandate to supply price stability. If prices are rising too fast, a central bank will put on the brakes and raise interest rates to cut off, the acceleration in prices. If prices are declining, a central bank will generate stimulus by lowering interest rates.
What Data is used in Fundamental Analysis?
There are many economic data points that a central bank will evaluate, but the ones that carry the most weight are job creating, GDP and consumer inflation. Additionally, a central bank will also look at consumer spending and retail sales, along with sentiment surveys and wholesale inflation. Because central banks follow these numbers, economists and traders also follow these numbers. Country’s release there reports on a daily basis throughout the month. What traders actually track is how those number fair relative to expectations. Since most traders believe that all the current information is already priced in a currency pair, the market needs new unexpected information to change the value of an exchange rate.
Forex fundamental analysis, is the process of looking at the interest rate differential between two currencies and seeing how the change in the relative value of one currency to another will effect an exchange rate. So in essence you need to trade how the economic data is doing in multiple countries or monetary unions. For example, the EUR/USD tracks the performance of the economies in the European monetary union as well as the United States.
You can use a financial calendar that is provided by your broker to track economic releases as well as the actual release versus what was expected by market participants. You will also need to follow what is said by central bankers, before their meetings as well as after their decision on monetary policy. Geopolitics are part of fundamental analysis, as traders want to know if a country will see an outflow of assets due to political concerns. The combination of economic analysis, monetary policy and political evaluation makes up the macro view that is considered fundamental analysis.