Fundamental analysis is a way of looking at the forex market by analyzing economic, social, and political forces that may affect currency prices.
When it comes to choosing a trading strategy, new Forex traders face many challenges. Technical analysis is not the only thing you need, as some people claim. To become a profitable trader, you must understand that fundamental analysis is just as important as technical analysis. Our goal in this article is to teach you how to use fundamental analysis to make excellent investing decisions.
What is Fundamental Analysis?
An important method of market analysis, the fundamental analysis considers economic fundamentals to identify trading opportunities for a given asset, sector, or economy. Inflation, interest rates, and employment rates are closely monitored by fundamentalist traders. In order to make rational decisions about what position to take, traders and investors need to gather the right information. Furthermore, you can predict economic conditions very well and have a clear picture of the general state of the economy.
What Does Fundamental Analysis Entail?
The fundamental analysis is performed by taking into account all external factors that can affect a currency or a currency pair and can change its supply and demand balance, including economic, political, and geopolitical events, as well as seasonality.
To master this part of fundamental analysis, one thing is essential: the economic calendar. A central bank, a reserve bank, or a private company releases information in an economic calendar to show the economy’s performance, which can affect a currency’s value.
It is important to determine when you want to commit to trading the fundamental aspect of economic releases. Traders must prepare for and be aware of these releases in advance.
Political and Geopolitical Events
War, elections, power changes, and natural disasters are also important components of fundamental analysis. When a war breaks out or a ceasefire is declared, the currencies of the nations at war are impacted significantly. The value of a nation’s currency can be significantly affected by a change in regime or political majority. It is possible for a nation that has changed power to have their currency completely revalued or devalued. Natural disasters typically cause a country’s currency to appreciate in the short run, but can harm it in the long run.
Several seasonal factors are involved in the seasonality, such as the “January Effect”, a perceived seasonal increase in stock prices in January.
To claim capital losses on their taxes, many investors will sell equities that have declined throughout the year at the end of the calendar year.
What are the approaches to conduct fundamental analysis?
There is a top-down and a bottom-up approach to fundamental analysis. Fundamental analysis can be divided into two approaches: top-down and bottom-up. The balance of trade and interest rates are also ways to perform fundamental analysis.
In top-down analysis, investors identify the currency pairs with potential profits based on macroeconomic factors such as interest rates, inflation, and GDP levels.
Alternatively, a bottom-up approach begins by analyzing the currency pair and works upwards to aggregate macroeconomic data.
Balance of Trade and Interest Rates
These factors primarily drive currency movements. A country with a trade surplus has a higher demand for its goods and services, which raises the value of its currency. A rise in relative interest rates also increases money value because more cash is coming in.
Fundamental market analysis can significantly impact the overall success of trade for those who are not purely technical. An asset’s fundamental analysis seeks to understand its value rather than establishing entry and exit points, which allows traders to view the market more long-term.
Combining fundamental and technical analysis can help you identify trade opportunities and manage your trades more effectively.