When individuals talk about fundamentals, they’re referring to the economic fundamentals of the currency’s host country.
Economic fundamentals encompass a wide range of information, including economic, political, and environmental reports, data, announcements, and events.
A credit rating downgrade is also considered fundamental data.
The usage and study of these aspects is known as fundamental analysis.
It is the study of what is going on in the world and around us in terms of economics and finance, and it tends to focus on how macroeconomic elements (such as economic growth, inflation, and unemployment) affect whatever we’re trading.
Basically, Fundamental analysis in forex is the study of economic, financial, and other qualitative and quantitative factors to forecast the future performance of a currency. It involves analyzing a country’s economic indicators, such as gross domestic product (GDP), inflation, interest rates, and political stability, to determine the value of its currency and predict future price movements.
The goal of fundamental analysis in forex is to determine a currency’s intrinsic value, which is then compared to its market price to determine whether the currency is overvalued or undervalued, and make trading decisions accordingly.
Fundamental Data and Its Many Forms
Fundamental analysis is researching economic trends and geopolitical events that may have an impact on currency pricing. To put it another way, it is the study of financial news and economic data.
The following are the most essential economic indicators to keep an eye on:
- Interest Rates
- GDP (Gross Domestic Product)
- Employment Data
When economic data is released, fundamental analysis provides insight into how price action “should” or may react to that data.
Fundamental Data can take many distinct forms.
It might appear as a Fed report on existing house sales in the United States. It is also possible that the European Central Bank will alter its monetary policy.
The public publication of this data frequently alters the economic landscape (or, more accurately, the economic psyche), causing investors and speculators to react.
There have also been cases where no specific report has been produced, but the anticipation of such a study is an illustration of fundamentals.
Interest rate hike speculation can be “priced in” hours or even days before the actual rate announcement.
Currency pairs have been known to fluctuate 100 pips only moments before important economic news, allowing for a rewarding trading opportunity for the bold.
That is why many forex traders are often on edge before key economic releases, and you should be as well!
In general, economic indicators account for a sizable amount of the data employed in fundamental analysis. Economic indicators, like a fire alarm blaring when it detects smoke, provide some insight into how well a country’s economy is doing.
While the numerical value of an indicator is significant, the market’s expectation of that number is equally crucial.
The most crucial component is understanding the impact of the actual figure in respect to the anticipated figure. When selecting to trade, all of these aspects must be considered.
The following is a typical analysis of economic releases and fundamental data reports:
“An increase in interest rates of that percentage MAY cause the euro to rise.”
“With an indicator value in that range, the US dollar SHOULD fall.”
“Consumer confidence has fallen 2% from the previous report.”
Here’s an Economic Report, Now What?
The market has a proclivity to react to how people feel. These emotions may be influenced by their reaction to economic information or their evaluation of current market conditions.
And, you got it, there are a lot of people, each with their own set of emotions and views.
“Geez, there’s a lot of uncertainty in fundamental analysis!” you’re probably thinking.
You are entirely correct.
There is no way to predict where a currency pair will move based on new fundamental data.
That is not to argue that fundamental analysis should be ignored.
The sheer volume of essential data accessible makes it difficult for most people to put it all together.
They comprehend a single report but are unable to integrate it into the larger economic picture. It simply takes time and a greater comprehension of the data to accomplish this.
Furthermore, because most basic data is published only for a single currency, fundamental data for the other currency in the pair would be required and compared to obtain an accurate picture.
As we previously stated, it is all about pairing a strong currency with a weak one.
You’re probably still waiting for a response to the question, “Will I ever need to apply fundamental analysis to become a good forex trader?”
We recognize that there are purists on both sides.
Short-term forex traders appear to prefer technical analysis, with price action as their primary focus.
Intermediate and medium-term traders, as well as some long-term traders, value fundamental analysis since it aids in currency pricing.
We’re going to be a little crazy and say you should use BOTH!
When a big fundamental event occurs, technical-focused solutions are blown to bits.
Similarly, pure fundamental traders miss out on the short-term chances presented by pattern formations and technical levels.
All viewpoints are covered by a combination of technical and fundamental analysis. You are aware of the upcoming economic releases and events, but you can also recognize and apply the numerous technical tools and patterns that market participants pay attention to.
Next Lesson: Why Interest Rates Matter to Forex Traders