Introduction

The Forex Market is a global marketplace where world currencies are exchanged against one another. The market participants include banks, corporations, governments, and individual traders.

Because the Forex Market is so large with so many different market participants, it is heavily impacted by ‘real world’ news events.

This is where fundamental analysis comes in. It involves analyzing data points to ascertain the value of different currencies and the possible future price action.

Some of the key data points used in fundamental analysis include the following:

• Economic Indicators

• Interest Rates

• Economic Performance

• Political Stability or Instability

• Geopolitical Events

• Natural Disasters

By analyzing these data points, traders seek to make more informed trading decisions, such as which currencies to buy (go long) or sell (go short).

Studying these data points – or fundamental analysis can be an excellent tool for predicting the expected moves of different currency pairs.

Understanding Forex Trading and Fundamental Analysis

The Forex Market is always traded in different currency pairs where traders bet on one currency relative to another.

In other words, if you are trading USD/JPY, USD represents the base currency, and JPY represents the quote currency.

When traders believe the Exchange Rate of the US Dollar (USD) will strengthen against the Japanese Yen (JPY), they will buy the currency pair.

Conversely, when traders believe that the Japanese Yen (JPY) will weaken again against the US Dollar (USD), they will sell the currency pair.

Because the strength of a currency is largely determined by the fundamentals of that country, there is much value in understanding what is drives the price of currency pairs either up or down.

The Impact of Global Events on Forex Markets

Fundamental analysis is one of the three primary types of analysis used by Forex Traders.

The three primary types of analysis are:

• Fundamental Analysis

• Technical Analysis

• Sentiment Analysis

There is a good argument that fundamental analysis drives the entire Forex Market, including price action (Technical Analysis) and the overall mood of market participants (Sentiment Analysis).

For example, if the US releases positive economic data, people will tend to turn ‘bullish’ on the US dollar, causing an influx of money into the dollar. This results in a higher exchange rate compared to other currencies and an overall more positive sentiment towards the dollar.

There are some specific key data points which are cornerstones of fundamental analysis:

1. Economic Indicators

These play a substantial role in indicating the health of a nation and the subsequent value of the nation’s currency.

There are four key metrics traders typically pay attention to:

--> Gross Domestic Product (GDP)

GDP is the monetary value of all finished goods and services made within a country during a specific period.

Essentially, it is a good measure of a country's economic health, and therefore, investors will be more inclined to invest in the country, inflating the value of the nation’s currency.

--> Employment / Unemployment Rates

Higher unemployment typically means less spending and reduced confidence in a nation.

Conversely, where unemployment is low, there tends to be more consumer spending and greater confidence in a country's health and well-being.

--> Inflation

Inflation measures how much more expensive goods and services have become over a certain period.

While moderate inflation is acceptable – even healthy, excessively high inflation can diminish the value of a currency and deter investors.

--> Interest Rates

Central banks often manipulate interest rates to keep inflation under control.

Higher interest rates mean investors get a higher return on their money, which makes the currency more attractive.

2. Political Events

It’s essential to understand the political events shaping the overall climate of a nation.

Traders and Investors are naturally drawn to a more stable political climate.

There are three main components traders watch relative to political events:

--> Elections

Elections typically bring much greater volatility and uncertainty into a country, as a change of leadership can result in policy changes and other reforms.

Pre and Post-elections tend to be particularly volatile periods.

--> Geopolitical Risks

Rising geopolitical risks cause a more negative sentiment towards a currency, and investors tend to flock to ‘safe-haven’ currencies.

Geopolitical tensions include things such as wars, terrorism, and cyberattacks.

--> Trade Agreements

When countries initiate new trade agreements or make amends to existing agreements, the goods and services of a country will be affected.

Favorable trade deals can boost a nation's economy and currency, while negative trade agreements have the opposite effect.

3. Natural Disasters

Natural disasters can ravage a nation's economy, and it can take years to fully recover from the devastation they cause.

This has a big impact on a country’s economic stability and the strength of the nation’s currency.

4. Central Bank Policies

Forex Traders pay close attention to central bank policy decisions, as they significantly impact a currency's value.

Central Bank decisions to increase or decrease the interest rate can cause an inflow or outflow of money into a currency.

Furthermore, their decisions also affect inflation and overall economic health.

How To Incorporate Fundamental Analysis Into Your Trading

Now that we know the impact of ‘real world’ news events on the market, how can traders incorporate this information into their trading strategies?

We will look at four specific ways that traders can incorporate fundamental analysis into their trading:

1. Pay Attention to Economic Calendars

By watching the economic calendars, you can see when there are upcoming news events and releases.

You may decide to hold off on trading when there is uncertainty or take a calculated risk ahead of time.

2. Follow the News Closely

One piece of breaking news can trigger a massive shift in the value of a currency.

Whether it is a change to a trade agreement with another country or reports of rising political instability, traders must keep abreast with the latest news.

3. Understand the Sentiment of Market Participants

It’s important for traders to identify and understand the overall mood and sentiment of market participants, which will typically influence currency prices.

However, it’s important to remember that the sentiment of market participants will largely be determined by fundamental analysis – or the actual ‘real-world’ happenings in a country.

4. Pay Close Attention to Economic Indicators

Traders need to pay attention to the economic data released, including things such as:

• Inflation Rates

• GDP

• Unemployment Figures

These data points provide keen insight into a country's overall health and should be carefully considered by traders looking to bet on currencies appreciating or depreciating.

Conclusion

Although Fundamental Analysis is just one of the tools at a trader's disposal, it is arguably the most important.

Because the Forex Market involves so many different currencies and market participants, just one piece of news can cause a sudden shift in market sentiment, resulting in price action.

Therefore, fundamental analysis is something no trader can afford to be without. Failure to incorporate it into your trading arsenal can have dire implications.