What separates a trader from a gambler or speculator is the fact that traders make decisions based on analysis.
We (the traders) don’t rely on feelings, emotions, the colour of the sky to pull the trigger. Any time a trade is taken, there should be a logical explanation behind it. We rely on facts and value the risk and the potential reward out of it.
Types of Analysis
In forex trading, we can categorize the types of analysis in three main groups: Fundamental Analysis, Technical Analysis and Sentiment Analysis. All of them have their strengths and weaknesses. Most retail traders rely on technical analysis. More experienced traders and longer-term investors on the fundamental, and the active traders, day traders love to work with sentiment analysis.
You don’t need to be on a pro-level on each of them, but understanding the basics, how they vary from another and how to take advantage of each at the right time. Doing this will increase your chances of being a successful trader. The idea is that each type of analysis is giving you a different perspective of the markets and a different set of tools to use in dealing with different market conditions.
Below we will cover the Fundamental analysis.
What is Fundamental Analysis in Forex?
Fundamental analysis is all the data, news and events which can impact the performance of a market. In stocks, this could be earnings reports etc. In Forex, fundamental analysis focuses on political, social and economic factors.
To accomplish that we shall look for information in the Economic Indicators. It might sound confusing at the moment but it really isn’t! These indicators are simple reports issued by the government itself (the government of the country we are analyzing) or private regulators \ bureaus, where we can see how strong and healthy the economy of this country is.
There are a number of major economic indicators (reports) that you should get familiar with. They tend to have a greater impact on the markets. These indicators are published during different periods of time. The time interval could vary from bi-monthly to monthly, quarterly, annually and so on. There are plenty of websites that offer free economic calendars that will give you an idea when the next major event is taking place and can be filtered by level of importance.
Here are two examples of such economic calendars.
You will notice that they carry pretty much the same information. Time, the currency which could be affected by the report, the impact that it might have, the name of the economic indicator. The last three columns are usually dedicated for the numbers.
- “Previous” – this column shows us what the previous reading from this indicator was.
- “Forecast” – what experts are expecting the number to be.
- “Actual” – the official number after the report is released.
We are mostly interested in the Forecast and Actual numbers. If there is a large discrepancy between the two, usually the market will react with strong volatility right after the publication.
Back to some of the most important indicators.
- GPD (Gross Domestic Product) – when we talk about the economy of a country, this is the easiest way to relatively measure its strength without being an expert in fundamental analysis. We can compare the GDP data to the gross profit margin of a company.
- CPI (Consumer Price Index) – over 200 categories are used to measure the changes in consumer goods. Usually used in collaboration with the nation’s exports to determine whether the country is profiting or losing on its production.
- Employment Change – Released on a monthly basis, this report reflects the changes number of employed people. It is important because job openings are tightly correlated to consumer spending and that gives us a broad idea of which direction the economy is going.
- Unemployment Rate – Here we are looking at the percentage of unemployed people (from the active working force of the nation). The number is important for pretty much the same reasons as we discussed above in Employment Change – consumer spending. More unemployed people equal less spending.
- Retail Sales – this economic indicator measures consumer spending. It is very useful for identifying seasonal trends and changes.
Those should be enough to get you started.
The economic events that we discussed above are relatively short-term indicators. Most of them are issued on a monthly basis.
Longer-Term Economic Factors
One of the main factors of this group is – Interest Rate.
The interest rate plays a huge role in the value of the currency of a given nation. Generally speaking, the higher the interest rate is, the more attractive that currency becomes. This, on the other hand, increases its value as it attracts investors, which ultimately makes the currency more expensive, compared to other nations’ currencies.
Great, so high-interest rate… but how do I use it in my trading?
For example, if the US is expected to hike its interest rates a few times during the year, and the Euro Zone is expected to hold or decrease its rates, it’s expected that the EURUSD currency pair will be trading on the downtrend where the Dollar will be stronger. And looking for trading opportunities in that direction will give the trader better chances.
And here is where it becomes really interesting. If you have an idea in which direction the fundamentals are pointing and you also have technical skills to read the price action on the chart, you can make much better decisions. When the technical analysis agrees with the direction of the Fundamentals, you know that you have a much safer trading opportunity ahead of you and better chances to gain good returns.
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