In currency trading, there are two types of philosophies currency traders use to justify trades. Those two philosophies are fundamental analysis and technical analysis. I know both terms can seem intimidating, but it isn’t as difficult to understand as you may think. On this page, I will be covering fundamental analysis.
If you are wondering what fundamental analysis is and why it is important in forex trading, don’t worry because I will answer those questions and more on this page. So sit back, relax and be prepared to gain a solid understanding of fundamental analysis and how it pertains to currency trading.
What is Fundamental Analysis
Fundamental analysis as it pertains to currency trading, is the philosophy of assessing economic data, fiscal policies and or monetary policies before entering a currency trade. It is the act of analyzing the fundamentals of an economy. Fundamental analysis does not include assessing currency trading price charts. A currency trader that uses fundamental analysis as one’s basis for entering and exiting a currency trade is known as a fundamental trader (other names: fundamental currency trader and fundamental Forex trader).
A currency trader who uses fundamental analysis will assess a country’s economic data before taking action on the country’s currency. Is the country experiencing positive and steady gross domestic product growth? What is the country’s employment and unemployment situation like? What about its inflation situation? Is the country experiencing a positive trade balance or a negative one? How does the country’s retail sales look?
These are all very important fundamental economic factors a currency trader will assess when performing fundamental analysis. A country with strong economic data will probably have a currency worth buying. A country with weak economic data will probably have a currency worth selling. It is my opinion that a currency trader should not buy a currency of a country who is suffering from poor economic data and to not sell a currency of a country who is experiencing strong economic data. Please be aware that there are many exceptions to this little rule.
There may be some instances when buying a currency of a country that is suffering from poor economic data can lead to profit. And there may be some instances when selling a currency of a country that is experiencing positive economic data can also lead to profit. The inverse may also happen as well. You may experience a loss if you buy a currency of a country that is experiencing positive economic data or experience a loss from selling a currency of a country who is suffering from poor economic data.
Currency trading is weird like that. There are a variety of factors a master currency trader must consider before acting. In the world of probabilities, if one follows my simple opinion of only buying a country’s currency if that country is experiencing positive economic data and only selling a country’s currency if that country is suffering from poor economic data, then the probability of profitability is increased. One side note. Currency trading using fundamental analysis is all relative between countries.
What about fiscal policies? Well, a currency trader that uses fundamental analysis may want to look at a country’s fiscal policies and use that as one factor to help determine whether to buy or sell a currency. A currency trader who is performing fundamental analysis will look at a country’s government and its fiscal policies to asses its condition. Is the government running a deficit? How severe of a deficit is the government running? How much debt does the country have? What percentage of the country’s gross domestic product does the country have in debt? These are all questions that a fundamental currency trader may want to know.
If a country has sound fiscal policies in place, then a currency trader may want to consider buying that country’s currency. Proper fiscal policies can and often does promote better economic data. When a country is has no deficit, little to no debt and is spending the money it brings in wisely as determined by the public and the private sector, then public confidence in that country will improve. That will encourage investing in that country and prompt economic growth.
An environment where fiscal policies are properly implemented provides a optimal space for economic growth. Economic growth with proper monetary policies tends to make a currency look very appealing to buy. However, let’s not forget about the opposite. If a government is implementing poor fiscal policies, which means it is running a significant deficit, increasing its debt load at a detrimental pace and spending money unwisely as deemed by the public and the private sector, it is my opinion that a currency trader should not consider buying that country’s currency and consider selling it.
Poor fiscal policies introduces public uncertainty and doubt. That will lead to less business investments and less economic growth. Sometimes poor fiscal policies may even directly hinder economic growth which will manifest more economic woes. A slowing in economic growth will make itself known through poor economic data. Less than optimal fiscal polices will create an environment that will make it unnecessarily tedious for economic growth to occur and it will drive public confidence down. Due to that fact, it is my opinion that a currency trader should sell a country’s currency if that country is suffering from poor fiscal policies. Remember, everything is relative.
Fundamental analysis also covers monetary policy assessment, which in my opinion is the most important component. A currency trader that is looking to perform fundamental analysis may, and should, study and take heed of the monetary policies implemented by a country’s central bank. It is the central bank that directly influences a currency’s trading price. All other fundamental factors like economic data, fiscal polices and whatever other factors I may have missed are nothing but information that is considered by central bankers when formulating monetary policy.
It is really the monetary policies that make currency price trading valuations fluctuate. Currency traders that use fundamental analysis should inquire about monetary policies before deciding to buy or sell a currency. Is the country’s central bank implementing expansionary monetary policies or contractionary monetary policies? More specifically, will the central bank hike interest rates or cut them? Are the central bankers all agreeing or are they divided on what monetary policy they should implement? These questions and more may be considered by a fundamental currency trader.
You should now have a good understanding of what fundamental analysis is as it pertains to currency trading.