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Fundamental Analysis
Guide to Forex Trading
What influences prices in the currencies market?
Prices in the currencies market are affected by macroeconomic factors, such as inflation, unemployment, and industrial production. Information on events such as these is easy to find and are based on their analysis of economic data, which traders take positions on the market to make profit.
There are three main macroeconomic factors a trader should focus on when analyzing foreign exchange rates:
Interest Rates:
Each currency has an overnight lending rate attached to it which is determined by that country's central bank. Lower interest rates usually lead to depreciation in the value of the country's currency.
This is largely due to traders who execute carry-trades. A carry-trade is a trade where a currency with a low interest rate is sold and a currency with a high interest is bought. This is based on the idea that currencies with higher interest rates will generally rise in value, and will rollover and allow trades to earn interest on a daily basis.
Employment:
The unemployment rate is a key indicator of its economic strength. If a country has a high unemployment rate, it means its economy is not strong enough to provide people with jobs, and thus, leads to a decline in the currency value.
Geopolitical Events:
Key international political events that affect not only the foreign exchange market, but all other markets as well.
Fundamental Analysis Techniques
How does fundamental analysis explain long term trends?
Fundamental analysis is very useful for determining long-term trends within a currency pair. By focusing on long term economic factors that affect countries, fundamental analysis predicts long term trends. For example, the rising cost of Crude Oil led to a downward trend in the USD/CAD from 2003 through September of 2005.
A graph of the USD/CAD, from October 2002 to October 2005
This graph shows the long term downward trend of the USD/CAD over the past three years, which is composed of smaller trends. Can fundamental analysis explain short-term trends?
Fundamental analysis can also explain short-term trends. By keeping up to date with economic data, rumors, and news, a fundamental trader can better forecast short term trends since these are all factors that affect currency pricing. For example, on May 29th of 2005, France was widely expected to vote against accepting the European Union Constitution, which had been causing steady weakness in the EUR/USD currency pair. In spite of expectations, when the no vote was confirmed, the currency pair sold off more than 400 pips in the next three days.
Short term selling of over 400 pips in three days
Currency Pair Descriptions
Please Note: The information below is not intended to be a trading recommendation.
EUR/USD
Dollar weakness drives EUR/USD higher.
U.S. recovery and strong influx of foreign demand will send EUR/USD lower.
If you think the U.S. economy will become weaker and hurt the US Dollar, you click on BUY, which means that you are buying Euros and expecting them to go up against the US Dollar.
If you think that there will be increased foreign demand for U.S. assets such as equities and treasuries and that will benefit the U.S. Dollar, click on SELL, which means that you are buying U.S. Dollars, expecting them to climb in value against the Euro.
USD/JPY
Japanese government intervention to weaken their currency sends USD/JPY higher.
Gains in Nikkei and demand for Japanese assets drive USD/JPY down.
If, for example, you think that the Japanese government will continue to weaken the yen in order to help its export industry, you would click on BUY, expecting the U.S. dollar to increase in value against the yen. If you think that Japanese investors are pulling money out of U.S. financial markets and repatriating funds back into the Japanese asset markets, such as the Nikkei, you would click on SELL. This means that you expect the Yen to strengthen against the U.S. Dollar as Japanese investors sell their assets and convert their Dollars back into Yen.
GBP/USD
High Yield and attractive growth in the UK drives GBP/USD higher.
Speculation about UK adopting the euro will send the GBP/USD lower.
If, for example, you think the British economy will continue to benefit from its high yield and attractive growth, thus buoying the Pound, you would click BUY, which means that you expect the British Pound to strengthen against the U.S. Dollar. If you believe the British are about to commit themselves to adopting the Euro, you would click SELL, expecting the Pound to weaken against the Dollar as the British devalue their currency in anticipation of merging with the euro.
USD/CHF
Global stability and global recovery will send USD/CHF higher.
USD/CHF rallies on geopolitical instability.
If, for example, you think that the market is headed towards a period of global stability and economic recovery, meaning that investors no longer need to park their money in the safe haven currency such as the Swiss Franc, you would click BUY, expecting the U.S. Dollar to strengthen against the Swiss Franc. If you believe that due to instability in the Middle East and in U.S. financial markets, the dollar will continue to weaken, you would click SELL, expecting the Swiss Franc to strengthen against the dollar.
EUR/CHF
Swiss government uses verbal intervention to weaken the Franc, sending EUR/CHF higher.
If inflation took off Germany and France it could drive EUR/CHF lower.
If, for example, you think the Swiss government wishes to devalue the currency to help exports in Europe, you would click BUY, expecting the Euro to increase in value against the Swiss Franc. If inflation started taking off in Germany and France, you would click SELL expecting the Swiss Franc to increase in value against a devalued Euro.
AUD/USD
Rising commodity prices sends AUD/USD higher.
Droughts hurt Australian economy and AUD/USD.
If, for example, you think that commodity prices are going to rise dramatically, thus benefiting the Australian Dollar, you would click BUY, expecting the Aussie to strengthen against the U.S. Dollar due to Australia's status as one of the world's leading commodity exporters. If you believe that Australia will face another drought, hurting the domestic economy, you would click SELL, expecting the U.S. Dollar to strengthen against the Australian Dollar.
USD/CAD
Canadian economic underperformance against US sends USD/CAD higher.
Higher interest rates and rebounding labor market in Canada will help to drive USD/CAD lower.
If, for example, you think that the U.S. economy is going to rebound while the Canadian economy goes into recession, you would click BUY, expecting the U.S. Dollar to strengthen against the Canadian Dollar. If you believe that the higher yields and rebounding labor market in Canada warrants a higher valuation for the Canadian Dollar against the U.S. dollar, you would click SELL, expecting the Canadian Dollar to decline against the U.S. dollar.
NZD/USD
Bad weather in U.S. increases demand for foreign wheat sending NZD/USD higher.
New Zealand Interest rates expected to decrease sending NZD/USD lower.
If, for example, you think that Hurricane damage in the US will lead to an increase for wheat imports from foreign nations such as New Zealand, you would click BUY, expecting the New Zealand Dollar to strengthen in value against the U.S. dollar. If you felt that interest rates in New Zealand would fall in the future while interest rates in the US will continue to rise, you would click SELL expecting the New Zealand to drop in value against the U.S. Dollar.