Understanding Fundamental Analysis

Fundamental events dictate the basis of all Forex market moves. Fundamental analysis seeks to forecast these moves by predicting money flows into and out of a particular currency by the study and interpretation of economic data.

The strength of this approach comes from its use of key economic events. As these 'fundamental' events will ultimately determine the value of a currency, they provide a useful tool for the Forex Trader in determining trends in the Forex markets.

Scheduled Fundamental Event Risk

Market events under the heading of Fundamental Analysis are normally a result of scheduled news releases. These include a number of reports on the state of the economy including unemployment, trade balance figures, inflation reports and interest rates.

Figures from these reports are speculated upon by both traders and analysts prior to their release. They are then further digested by buyers and sellers in the market upon release.

The interpretation of this data and its perceived effect on the market will dictate the direction of currency flows.So quite simply, the task for the fundamental analyst is to try to anticipate whether the figures in the release will be better than, worse than or in line with expectations. The next step is to decide as to what effect, if any, they may have on prices.

It is quite possible that a release will under or over shoot the prior expectations of the market. This can cause a high level of volatility in the markets as traders quickly re balance their positions.

In summary:

• Positive reports will tend to reflect sound economics and be bullish for the currency.
• Expected or negative figures are more likely to have a neutral or negative effect on the currency.

Unscheduled Fundamental Event Risk

As well as covering scheduled market risk, Fundamental Analysis also encompasses what we will term ‘unscheduled risk’ or ‘event risk’.

This wide umbrella includes anything that is not specifically scheduled for release to the market. This includes a wide range of global events encompassing political events, wars, elections, natural disasters and even terrorism. As with stock markets, Forex markets dislike uncertainty and these events, when they occur, can cause a sudden and dramatic shift in sentiment.

A good example of this is the correlation between the oil price and the Canadian Dollar (CAD). As the oil price increases so too does the CAD. Canada is still one of the top 10 oil producers and its reliance on this commodity is paramount to its economy. Therefore any event which causes a spike or dip in oil prices is likely to see at least a temporary re rating of the currency.

While undoubtedly fundamental analysis is the driver of long term market trends, it struggles to provide defined entry points for traders.

Markets also do not always react to news in a rational manner which again proves problematic in using this approach to timing trade entries.

For this we turn to Technical Analysis. But before doing this it is important to take a look at the key fundamental events that help to shape the broader direction of the markets.

Next: Interest Rates