Forex fundamental analysis
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omid - Blog
omidIntroduction:
Analyzes are very important tools in the financial markets, including the forex market. One of the most important types of analysis that helps us understand the true value of trading currency pairs is forex fundamental analysis. But what is this analysis and why is it important?
In this article, we will examine the fundamental analysis in the forex market.
What is Forex Fundamental Analysis?
Fundamental analysis, also called fundamental analysis, is a method of market evaluation that uses multiple data sources to find the true value of currency pairs. Unlike technical analysis, which only looks at price performance, in fundamental analysis, the main assumption is that the price of a currency pair may be different from its real value. Therefore, this analysis tries to provide a comprehensive picture of the strengths and weaknesses of a currency pair.
Forex fundamental analysis can include the examination of economic and financial factors such as interest rates, inflation, microeconomic indicators and consumer behavior, political factors and even the impact of natural events such as floods and droughts.
Traders who use the art of forex fundamental analysis in their trading strategy evaluate any data that is likely to have a significant impact on the price of a currency pair. They look for catalysts that cause a sudden spike in demand for a currency pair, a market trend reinforcement, or a breakout. The ultimate goal of these traders is to understand the real value of a currency pair, compare it with the current price and find the right trading opportunity.
Why is Forex fundamental analysis important?
Technical analysis charts provide us with a lot of information about the market, including market direction, momentum, support and resistance points; But when we judge only from the chart and do not consider major economic and political changes in the trade, we may miss big price movements.
For example, when Britain left the European Union, people lost some confidence in the pound. As a result, every currency pair that included the British pound suffered. Against the US dollar, the pound fell by almost 20% over the following weeks before rallying again. What happened? Only traders doing fundamental analysis could see that the pound was gaining strength again and used this situation as a golden trading opportunity.
Advantages of fundamental forex analysis
Fundamental analysis is based on the idea that every currency pair has a real value. Even if, in a temporary period, the markets value a currency pair more or less than it should, eventually, that currency pair will return to its true value. Some of the advantages of Forex fundamental analysis are:
1. It helps to make informed decisions in transactions.
2. It identifies macroeconomic trends and risks by analyzing fundamental factors such as GDP growth, interest rates, unemployment, etc.
3. With the information it provides to traders, it enables better prediction of price changes.
4. It reveals the true value of currencies.
5. Improves long-term trading strategies.
Disadvantages of forex fundamental analysis
With all the advantages that we have said, fundamental analysis also has disadvantages, which are as follows:
1. There is no guarantee that your chosen currency pair will move towards its true value; Even if you research it thoroughly. A completely unpredictable event can throw off all your estimates. The market may even stay at its unrealistic pricing longer than you can hold your position open.
2. Fundamental analysis requires extensive research and knowledge for proper evaluation and interpretation. There are many economic indicators, policies, and events to consider.
3. Interpretation of fundamental factors is subjective and may lead to wrong signals and conclusions.
4. Unlike technical indicators, fundamental indicators do not contain precise numerical data and are mostly analyzed qualitatively, which may be affected by biases and incorrect readings.
Basic factors in forex fundamental analysis
As we said, the resources available to a fundamental trader are wide and varied. However, some of them are more important:
1. Economic indicators
Economic indicators are reports published by a government or a private organization that detail the economic performance of a country. These reports are tools for measuring the economic health of a country. For example, GDP, unemployment rate and inflation are among the most important factors affecting currency valuation.
Consumer price index and inflation
The Consumer Price Index or CPI measures changes in the price of consumer goods and significantly affects fundamental analysis in forex trading. A rise in the CPI indicates higher inflation, which directly affects the central bank’s decision on interest rates and monetary policies, which in turn affects the strength of the currency.
Over a long period of time, as the economy grows, the amount of money in circulation, which is the definition of inflation, must grow. Inflation occurs when the purchasing power of a given currency decreases, and central banks are usually tasked with controlling it.
GDP
Gross Domestic Product (GDP) is a measure of all goods and services produced in an economy over a given period and is believed to be the best indicator of an economy’s overall health.
GDP by itself is not a useful indicator, however, the rate of change in GDP over a period of time can provide a lot of information about the health of an economy; For example, whether the economy is growing or not. This in turn can give you an indication of the strength of a country’s currency. An increase in GDP is likely to have a positive effect on the value of a currency.
2. Central bank policies
Changes in interest rates, economic stimulus programs, the position of central banks such as the US Federal Reserve, the European Central Bank or the Bank of Japan can change currency correlations and fundamental forecasts.
For example, when the central bank lowers interest rates, banks and people are encouraged to borrow and spend, and the economy is strengthened. Of course, in the long run, low interest rates can cause the economy to face inflation; Therefore, it is a solution in the short term and it is considered a weak strategy in the long term. As a result, to prevent economic collapse, central banks increase interest rates.
From a forex fundamental analysis perspective, the best place to start looking for trading opportunities is interest rate changes.
3. Political and geopolitical changes
Important political events, elections, contracts, scandals, war or revolution, can quickly affect fundamental forecasts. For example, an increase in conflict in the Middle East can put pressure on the world’s oil supply and increase its price. As a result, businesses that rely heavily on oil may see their profits decline.
4. Unexpected events
Unwanted events such as natural disasters, credit crisis, bank collapse or global diseases can cause abnormal price movements of currency pairs.
5. Market sentiment
Collective mentalities, speculation, broad trends and emotional behavior of investors and traders in the market can affect the fundamental analysis of the forex market.
How to use data sources for fundamental analysis?
The best way to keep track of news events is the forex calendar. This calendar is an essential tool for fundamental analysis that provides a daily schedule of scheduled economic announcements.
A strong economy is a good sign for investment; Because it has the possibility of higher returns in the financial markets. However, it is not always that simple. Sometimes we have examples of healthy economies that have weak currencies. Currencies are not like stocks of a company that directly reflect the health of the economy.
When economic reports are released, look for signs of strength or weakness in various economies. If market sentiment moves in one direction before the news is released, the pre-release price change is known as “market price.”
Conversely, when the market is uncertain or data results differ from forecasts, it may cause extreme volatility in the market. In such a situation, it is better to stay away from trading around news when performing fundamental analysis.
