Forex Fundamental Analysis
Forex fundamental analysis involves several factors to consider. Each of them provide useful information that, when combined, comes up a big picture of what is going on in the world and future economic events can be forecasted. It is here where you make your decision to trade currencies and expect good profits.
The factors to consider in forex fundamental analysis are:
The economic indicators have to do with what happens in the world and in specific countries, like the gross domestic product, employment, inflation, sales, consumer spending, etc. They are released in pairs, where the first number reflects the latest period and the second number is the revised figure for the month prior to the latest period. For instance, in May, economic data is released for the month of April, the latest period. In addition, the release includes the revision of the same economic indicator figure for the month of March. This is important for traders so they know exactly what economic data is relevant and which one is not.
Economic indicators are released at different times, starting at 8:30 am until 10:00 am Eastern Time (United States).
You can see the future economic indicators published in major newspapers, like New York Times, Financial Times and the Wall Street Journal. You can also monitor them on Reuters or Bloomberg.
Financial factors are vital to fundamental analysis. Changes in a government's monetary or fiscal policies usually generate changes in the economy, and these will be reflected in the exchange rates. Financial factors are triggered by economic factors and when governments focus on different aspects of the economy or have additional international responsibilities, financial factors have priority over economic factors.
Because foreign exchange is the simultaneous transactions in two currencies, the market focuses on two respective interest rates as well. This is the interest rate differential, and traders react when it changes, not only when the interest rates change.
Most of the time the discount rates are cut unilaterally and this generates changes in both the interest differential and the exchange rate. Traders approach the interest rates like any other factor, trading on expectations and facts. For example, if rumor says that a discount rate will be cut, the respective currency will be sold before the fact. Once the cut occurs, it is quite possible that the currency will be bought back, or vice versa. An unexpected change in interest rates is likely to trigger a sharp currency move. It is common that traders follow the saying "Buy on the rumor, sell on the fact".
Other factors play an important role before making a trading decision, like the time lag between the rumor and the fact, the reasons behind the interest rate change, and the perceived importance of the change.
If the discount rate was changed for political reasons (a common practice in the European Monetary System), the markets are likely to go against the central banks, sticking to the real fundamentals rather than the political ones.
At the end, traders deal on the perceived importance of a change in the interest rate differential.
Political events generally take place over a period of time, but political crises strike suddenly. They are unexpected. Currency traders are very skilled responding to crises. Speed is essential and reflexes take over. Without fast action, traders can be left out in the cold. There is no time for analysis, and they only have a split second, at best, to act. As volume drops dramatically, trading is hindered by a crisis. Prices dry out quickly, and sometimes the spreads between bid and offer jump from 5 pips to 100 pips. Getting back to the market is difficult.
Those are the main factors to consider in forex fundamental analysis.
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