Let’s see in this article what the fundamental analysis in forex is and how traders use it in their daily trading activity.
What is the fundamental analysis in forex?
It’s basically a method of analysing the forex market to see if there is any potential situation that could change the supply and demand of an asset, as well as affect the movement of a currency.
Supply and demand is a classic trading principle that has been used by traders since ancient times to determine prices. These days it allows forex traders to establish the currency exchange rate for the forex market.
However, when supply and demand is used by traders, they must also use analysis alongside it in order to analyse all the different conditions that influence supply and demand.
Although forex traders are not fortune-tellers, it is possible for traders to assess the following conditions which can help them to make an educated guess of what situation may adjust the supply and demand.
The 3 Fundamental Conditions
These are the 3 main fundamental conditions that must be analysed:
- Political conditions
- Economic conditions
- Social conditions
All the above fundamental conditions can shape and change the forex market as the market reacts to any major changes that impact the exchange rate and assets. Let’s look at some examples of these now.
Political conditions for instance can include governmental changes, election results and political relations with other countries. One good example of this is the on-going trade ‘war’ between the USA and China which has affected trade tariffs, this in turn has affected the USD value.
Economic conditions basically look at how healthy a countries economy in terms of their GDP growth rates, inflation and general economic policies.
Social conditions include data such as a countries current unemployment rate and the housing market prices.
It may not be immediately clear why for a countries unemployment rate should affect it’s currency. However the main point is that an increase in the unemployment rate would affect the country’s economy negatively, therefore changing the currency’s demand level.
The main thing to remember about fundamental analysis, is that if a nation’s future and present economic positions look good, their currency should also increase in value.
This is why traders use fundamental analysis in forex to examine possible changes that would affect currency value. It also helps to understand which countries economies are doing well and which ones are not.
When a countries’ economy is strong and performing well, this naturally attracts more wealth and funding as overseas companies will want to invest in that country. For foreign companies to buy their investments, they will need to buy up that countries national currency in order to purchase and acquire the planned investments.
This will cause the value of the national currency to increase due to the economy improving from outside investment and wealth creation.
Of course for forex, traders should also be on the lookout for countries whose economic situations aren’t looking so healthy, as this is a sign that a currency may drop in value.
Example of Fundamental Analysis
Let’s picture a situation where an economy is struggling:
imagine and say that in Britain, for example, the GBP has been dropping in value because the British economy is struggling.
When the economy continues to weaken, the banks may need to lower interest rates to manage inflation and prices. These lower interest rates will cause GBP listed financial resources and assets to be less attractive to investors.
So to avoid losses, investors and brokers must sell their GBP denominated assets.
This action, plus the fact that the economy is struggling, would likely cause the GBP to fall in value and affect the forex market.
Conclusion to Fundamental Analysis in Forex
Although fundamental analysis in forex sounds complicated, hopefully this article shows that it doesn’t have to be a headache for traders. However, we would always recommend that each forex trader keeps a note of all major global news events to stay up to date with what’s happening in the world.
That way a forex trader can always be ready to analyse any potential event that might affect a currency or country economically. It’s important to remember that with good analysis, can come good things.
To learn more about other important trading strategies follow this link.