Fundamental analysis is a way of looking at the forex market by studying economic trends, social forces and geopolitical events (and nowadays random tweets from a certain world leader) that affect the supply and demand of a certain currency.
It is the study of what’s going on in the world, economically and financially speaking, and it tends to focus on how macroeconomic elements (such as the growth of the economy, inflation, unemployment) affect whatever we’re trading.
Someone who uses fundamental analysis is called a fundamental analyst. Traders who use fundamental analysis are known as fundamental traders.
Ultimately, the point of fundamental analysis is to understand the reasons why and how certain events affect a country’s economy and monetary policies which ultimately, affect the level of demand for its currency.
The idea behind this type of analysis is that if a country’s current or future economic outlook is good, its currency should strengthen.
Essentially, it all boils down to supply and demand; a country with a strong and growing economy will experience stronger demand for their currency, which will work to lessen supply and drive up the value of the currency.
Or in other words, the better shape a country’s economy is, the more foreign businesses and investors will invest in that country.
There are various economic events that can have a huge impact on exchange rates. Below are some of the most important economic events that drive Forex price movement.
The GDP report is one of the most important of all economic indicators. GDP stands for gross domestic product, or the total value of the goods and services produced in a country over a specified period. It is used as an indicator of the size and health of a country’s economy.
The GDP number is released at 8:30 am EST on the last day of each quarter and it reflects the previous quarter’s activity.
The Consumer Price Index (CPI) is an important economic indicator released on a regular basis by central banks to give a timely glimpse into current growth and inflation levels.
Inflation tracked through CPI looks specifically at purchasing power and the rise of prices of goods and services in an economy, which can be used to influence a nation’s monetary policy.
The Producer Price Index, or PPI, is a monthly report released by the Bureau of Labor and Statistics that calculates and represents the average movement in selling prices from domestic production over time.
Forex traders can use PPI as a leading indicator to forecast consumer inflation measured by the Consumer Price Index (CPI).The PPI data is released during the second week of each month.
You will often hear traders and analysts talking about “NFP”, this means Non-Farm Employment report, and it is the one report each month that has the greatest power to move the markets.
This report comes out on the first Friday of every month at 8:30 am EST and includes the unemployment rate, which is the percentage of the work force that is unemployed, the number of new jobs created, the average hours worked per week, and average hourly earnings.
The NFP often results in significant market movement.
Interest rates make the forex world go ’round!
Seriously, the FX market is ruled by global interest rates.
All of the above mentioned economic reports are closely watched by the Federal Open Market Committee in order to gauge the overall health of the economy.
The Fed can use the tools at its disposal to lower, raise, or leave interest rates unchanged, depending on the evidence it has gathered on the health of the economy.
When a piece of economic data is released, fundamental analysis provides insight into how price action should or may react to a certain economic event.
That’s the most excited fundamental analysts get that month!
Are you one of them?