When you trade forex, there are a range of different strategies that you can use to take advantage of market movements. These usually fall into two types of trading strategies. You have technical analysis strategies and fundamental strategies. Technical strategies use indicators such as Bollinger bands, ADX charts and candlestick indicators.
These are both age old forex trading strategies that have proved themselves in different industries before and have been used successfully by a range of well known traders.
In this post we will take a look at fundamental analysis strategies as these are probably the starting point for most traders.
What is Fundamental Analysis
Fundamental analysis is the study of the underlying fundamentals of a currency. These include factors such as the country’s economic growth, inflation and interest rates. They tend to directly impact the underlying value of the currency through a range of economic disciplines.
They have been used by the likes of Warren Buffet on the stocks side and George Soros on the forex side. Traders will look at these fundamental factors and monitor what impact any changes could have on the price of the asset.
They are generally traders who will look more towards longer term holdings but can also do day trading based on price action events such as economic announcements.
What Fundamental Factors to Monitor
When it comes to trading forex with fundamental analysis, you need to monitor a few really important indicators as they are most likely to have a direct impact on the currency pair in question.
The first and most important fundamental factor to monitor is interest rates. This is the amount of return a holder is expected to get for keeping the currency in question. As the interest rate goes up so will the price of the asset. The opposite can of course be said for an example when the interest rate goes down.
When watching interest rates the most important economic announcements to keep an eye on are the policy announcements by people such as the central bank of a country or in the case of the USA, the Federal Reserve.
Another really important fundamental analysis factor to monitor is the Economic growth in the country. This is the GDP number and it is really important for the value of a currency.
When it comes to how well the value of the currency is backed, the strength of the country’s economy should be a really important indicator as to how secure that currency backing is. For example, although the USA has mountains of debt, the world knows that their economy is the strongest and as a result they are comfortable with the debt levels.
If you are trading a currency based on the economic numbers, one of the most important things to watch for is the release of the data such as GDP growth per quarter. These are usually the most important metric by which you can judge how likely the currency is to appreciate or depreciate.
You can also day trade this by taking a look at the market expectations of the GDP numbers vs what that actual number that is printed is. If the numbers miss the expectations or overshoot it there is likely to be a large reaction. Volatility is good for the Forex trader.
The rate of inflation is how much the price of the goods and services in a country increase each year. It is usually an indicator of how the purchasing power of a currency is changing. As a holder of the currency, inflation can be bad for your investment. It means that the purchasing power of your asset is decreasing.
Therefore, from a fundamental perspective you will want to avoid those currencies that have excess inflation.
Of course it is also not always that easy. Inflation can also be a precursor to the actions by the central bank on interest rates. Therefore, the trader would do best to balance the competing forces and weigh up the likelihood of drastic changes in these numbers.
In order to day trade this, the trader would want to monitor the CPI and PPI numbers that are coming out of the statistics offices. In a similar fashion to the GDP reading, you would have to compare the expectations of the inflation rate to the actual print of the inflation.
Trading Forex with fundamental analysis is not always as easy as it sounds. Not only do you have to accurately predict how interest rate and inflation numbers will change but you also have to know the exact impact on the assets in question. Not always is it that clear how the markets shall react to an announcement.
The best that you can do is to improve your knowledge of Forex trading and also monitor the statements that are being made by professional traders as they have important insights.