Trading in the foreign-exchange market (forex) relies on the same two basic forms of analysis that are used in the stock market, fundamental analysis and technical analysis. The use of technical analysis in forex reflects much the same as fundamental analysis; price reflects all news and the charts are the objects of analysis. Unlike companies countries have no balance sheets or profit and loss, many analysts question if fundamental analysis, in it’s original form, can be conducted on a currency.
Fundamental analysis looks to establish the intrinsic value of an investment, applying this methodology in forex trading requires observing the economic conditions that affect the valuation of a nation’s currency. Here are some of the major fundamental factors that affect the movement of a currency.
Economic indicators are reports released by the government or a private organisation that detail a country’s economic performance. Economic reports are the means by which a country’s economic health is directly measured, many factors and policies will affect a nation’s economic performance.
Reports are released at scheduled times, providing indicators of whether a nation’s economy has improved or declined. In forex, as in the stock market, any deviation from the norm can cause large price and volume movements.
Some of these economic reports, such as the unemployment numbers, are well publicised. Others, like housing stats, receive little coverage. Each indicator serves a particular purpose. Here are four major reports, some of which are comparable to particular fundamental indicators used by equity investors:
The Gross Domestic Product (GDP)
The GDP is considered the broadest and arguably best measure of a country’s economy, as it represents the total market value of all goods and services produced in a country during a given year. GDP is considered a lagging indicator, traders focus on the two reports that are issued in the months before the final GDP figures; advance and preliminary reports. Significant revisions between these reports causes volatility.
Retail-sales reports measures total receipts of retail stores in any given country. The measurement is derived from a diverse sample of retail stores in a nation. The report is useful as it’s a timely indicator of consumer spending, adjusted for seasonal variables. It’s used to predict the performance of other important lagging indicators, and to assess the immediate direction of an economy. Revisions to advanced reports of retail sales causes significant volatility. The retail sales report can be compared to the sales activity of a publicly traded company.
This report illustrates the change in the production of factories, mines and utilities within a nation. It reports ‘capacity utilisations’, the degree in which the capacity of each of these factories is being used. Ideally a nation should see an increase of production whilst being at its maximum (or near maximum) capacity utilisation.
Traders using this indicator are concerned with utility production, which can be volatile since the utilities industry, and the trading of and demand for energy, is heavily affected by changes in weather. Significant revisions between reports can be caused by weather changes, which causes volatility in the nation’s currency.
Consumer Price Index (CPI)
The CPI is a measure of the change in the prices of consumer goods across over 200 different categories. This report, when compared to a nation’s exports, can be used to monitor if a country is making or losing money on its products and services. To monitor the exports can be tricky as the prices of exports often change relative to a currency’s strength or weakness.
Some other major indicators include:
- The purchasing managers index (PMI)
- Producer price index (PPI)
- Durable goods report
- Employment cost index (ECI)
- Housing starts
- Michigan Consumer Confidence Survey
How Do Forex Traders Put These Reports To Work?
Economic indicators establish a country’s economic state, changes in the conditions reported will directly affect the price and volume of a country’s currency, however, the indicators listed above are not the only factors that affect currency price. There are third-party reports, technical factors, and many other issues that can drastically affect a currency’s valuation.
A Few Tips For Conducting Fundamental Analysis In The Forex Market
- Keep an economic calendar ready that lists the economic indicators release date whilst being aware of the future as markets can move in anticipation of a certain indicator or report due to be released at a later time.
- Be aware of the economic indicators that are being discussed most in the financial media at any given time. Such indicators are often catalysts for large price and volume movements, when the U.S. dollar is weak, inflation is often one of the most watched indicators.
- Bloomberg produce expectations based on questionnaires sent to leading economists in any given specialised field. Be aware of these market expectations for the data and pay attention as to whether expectations are met. It’s often more important than the data itself. Occasionally, there’s a drastic difference between the expectations and actual results, if there is be aware of the possible justifications for this difference.
- Never react too quickly to the news, numbers are released and then revised. Paying attention to these revisions may be a useful tool for seeing the trends and reacting more accurately to future reports. The adage is; “don’t trade the news, trade the reaction to the news.”
There are many economic releases and there are more private reports that can be used to evaluate the fundamentals of forex. It’s important to take time to look at the numbers and to understand what’s being translated and how these reports affect a nation’s economy. When properly used these reports and indicators of a country’s or state’s performance are a priceless resource for currency traders.