For many years the foundation of analysis in foreign currency trading was fundamental analysis but in recent years this has been replaced to a large extent by technical analysis. So, is forex fundamental analysis dead?
Fundamental analysis is essentially a case of examining the economic and political events which may affect currency prices and these events filter through into such things as a country's published economic policy, inflation, growth rates and unemployment rates. Thus, by looking at the historic effects of economic and political events on a country's currency traders are able to predict the effect which present events will have upon the currency today.
Just like other markets the currency market is affected by both supply and demand which are themselves influenced by economic conditions. Above all, both supply and demand will be affected by an economy's strength (as seen in its foreign investments, gross domestic product and balance of trade) as well as by interest rates.
For the forex trader fundamental analysis involves looking at current economic conditions which can be seen through the various indicators like producer price indexes, consumer price indexes, retail sales and durable goods orders which governments publish on a regular basis.
One key indicator for currency traders are interest rates as changes in interest rates can both weaken and strengthen a currency. For instance, while high interest rates may cause stock market investors to sell in the belief that increasing interest rates will also lead to higher borrowing costs for companies hitting the price of their shares, those same high interest rates could also strengthen the local currency so that it is an attractive currency to trade.
Yet another key set of indicators for the currency trader are international trade indicators. If a country is showing a deficit on its balance of trade it is usually seen as an adverse sign as money flowing out of the country to pay for foreign goods could well devalue the currency. For the foreign currency trader however fundamental analysis may well show that market expectations mean that a trade deficit in certain circumstances is not at all bad. For instance, many countries frequently operate with a trade deficit and so unless there is an unusual increase in this deficit the currency will already reflect this fact.
There are currently approximately twenty-eight major indicators in the United States which forex traders rely on to make their trading decisions because these indicators have a significant influence on the financial markets. At the same time other countries around the globe with well traded currencies also publish similar sets of indicators which once again have a major influence on their own markets. Currency traders need therefore to familiarize themselves with these indicators and need to have at least a working understanding of exactly how they influence currencies.
Fundamental analysis is far from simple and requires traders to deal with large amounts of data which often require some quite extensive analysis. Today however the advent of powerful personal computers and broadband Internet access mean that foreign currency traders can now not only quickly access the information that they need to carry out fundamental analysis but also have access to a number of very powerful programs which will analyze the information for them at the click of a mouse.
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