Forex Fundamental Analysis: What it is & How to do it?
Last Updated: July 13, 2020
Most people don’t realize this but top fx traders heavily rely on fundamental analysis which is a lesser-known but highly important part of the forex trading.
Technical analysis is the counterpart of forex fundamental analysis that also aids traders in determining the market prices using tools such as charts and indicators.
Forex fundamental analysis, on the other hand, focuses on analyzing the intrinsic value of securities because it is not possible to maintain the balance sheet of an entire country.
Fundamental analysis takes economic conditions and other factors that may affect the value of a country’s currency.
That being said, fundamental analysis is equally important to technical analysis and should be given equal importance before commencing any trade.
In this article, we will discuss what forex fundamental analysis is in great detail and how you can start implementing it in your future trades.
Forex Fundamental Analysis
As we mentioned before, fundamental analysis is used to ascertain the intrinsic values of securities while considering various factors.
These factors can be both qualitative or quantitative and they help the trader arrive at conclusions about the security’s price movements.
Since this analysis has many uncertain factors attached to it, it can be a little difficult to arrive at the most accurate conclusion.
However, this also makes fundamental analysis a tool that can be applied to all styles of trading whether its short, medium, or long position styled.
Since it is a long and somewhat complicated process, many traders end up ignoring or skipping it entirely.
However, traders should not take fundamental analysis lightly at all! It is a crucial step for the entire trading process which can prove to be very beneficial for you.
Before we explain the reason for that, let us try to understand the entire process of forex fundamental analysis in detail.
Different Approaches To Fundamental Analysis
There are a few ways in which traders conduct their fundamental analysis and research to be able to draw the most accurate data.
Top-Down Approach: In this approach, a trader may look at the aggregates of data and other factors that are part of macroeconomics.
The trader will continue in a downward direction while eliminating all irrelevant data.
At the very end, only those currency pairs that look promising are left after all other pairs have been filtered out.
Bottom-Up Approach: This approach works in the opposite manner of the top-down approach.
Desirable currencies are first identified and selected and all the other factors that affect them are analyzed late.
Major Factors To Look Out For
There are several tangible factors that you should pay close attention to while conducting fundamental analysis. They are-
Gross Domestic Product: GDP is used to accurately represent the measure of a country’s economic condition.
It is also a factor that is taken into account for fundamental analysis of forex currencies.
Economic Indicators: These are the reports generated by the government or in some cases, private corporations that represent a country’s current economical condition.
Consumer Price Index: The CPI indicator is used to evaluate whether a country is making a profit or a loss on the goods and services it is generating.
Industrial Productivity: This report shows the changes in the utilities of a nation by analyzing productivity rates of mines, factories, etc of a country.
Since these indicators directly represent how a well a country’s economic backbone is, their data can be easily incorporated in fundamental analysis in forex to determine the ups and downs in that particular country’s currency rates.
This can be an invaluable piece of data for any forex trader as it can help them make well-informed predictions regarding a country’s currency valuation.
Why Fundamental Analysis Is Necessary
In basic economics, they teach you that the price of any commodity in a free market tends to depend entirely on the forces of supply and demand.
Fundamental analysis deeply studies these forces to ascertain the current financial position of an entire country which directly impacts their currency value on the foreign exchange market.
This is why the data that a forex trader can derive from these reports are considered to be highly valuable.
Having this data automatically gives forex traders an edge. They can also use these skills and data to make some more income on the side by fronting other traders.
On the other hand, having such crucial data in your hands gives you an invaluable psychological advantage over other traders as you are completely in the loop of every rise and dip in the country’s currency value.
This psychological advantage also prepares you immensely for any losses that may incur along the way when the tide of the market is not to your advantage.
Why Fundamental Analysis Are Disregarded
The main reason why forex fundamental analysis is sidelined by most traders is due to the way they are taught to trade by their teachers or mentors.
Many retail forex traders often regard fundamental analysis as a waste of time and they believe that all the information they need to close successful trades can be found in their indicators and charts.
There are also some heavy misconceptions about forex trading which says that the help of a price chart is sufficient enough for you to make great trading decisions.
This is not true at all.
Currency prices are highly dynamic and volatile. Several factors such as neighbor relations, GDP, virus outbreaks, etc cab be blamed for their volatility.
Another reason why people disregard fundamental analysis in forex trading is that it can not be automated properly.
Most beginners heavily rely on automated systems which is why manually crunching the numbers seems like a herculean task for them which is why they end up avoiding the entire process altogether.
This might be an easy way out but it can prove to be a grave disadvantage for fx traders in the long run.
Finally, the biggest reason why traders skip the entire fundamental analysis process is simply because it is too complicated of a process to get into.
How Can You Implement Fundamental Analysis?
Now that you are aware of the importance of fundamental analysis when it comes to forex trading, let us talk about how you can go about incorporating it into your trading strategy.
As we said before, a variety of qualitative and quantitative factors are responsible for the shift in a country’s economy.
These factors may also include decisions taken by the Central Bank who is complete control of the country’s money, natural disaster, economic conditions, geopolitical events, and political tensions, etc.
The first thing you can do to implement forex fundamental analysis is to keep up with all upcoming events.
Thorough research on the previous and current market conditions of the country or countries that you are interested in can also be an invaluable asset.
Research may also include referring to an economic calendar that helps traders keep up with potential trades beforehand.
Investigate every big thing that has happened on the market and try to gather as much information as you can about it.
Find out who or what caused those big moves to occur in the first place and see how close you are to mimicking those conditions yourself.
Understanding the logic and reasoning behind those noteworthy trades will give you more confidence in your skills as a trader.
Now you know everything about forex fundamental analysis. Use this opportunity to research more on the subject and try to draw your conclusions.
Remember, information is key, and the more of it you have on your disposal the better off you will be under the harsh and volatile conditions of the foreign exchange market.
Trying to learn the entire process may seem too much of a chore at first but it pays off big time in the long run.
Traders who are new to the game should invest a portion of their time in researching this aspect of Fx trading as it will give them a significant advantage over other traders who chose to skip learning it.
Be sure to look out for economic factors such as decisions taken by the country’s Central Bank and other economic indicators such as GDP, Consumer Price Index (CPI), overall industrial production, etc.
Furthermore, we have also told you to look out for uncertain factors that may affect a country’s economic stability and consequently affect the currency value such as natural disasters, geopolitical issues which may lead to war between two neighboring countries, etc.
The recent COVID-19 outbreaks are the perfect examples of uncertain factors to look out for as the pandemic had brought many countries’ economies to a complete standstill.
If you take all such data into account while gathering data for your fundamental analysis process then you are sure to be able to derive near-perfect conclusions that will positively impact your trading decisions.