How to Perform Fundamental Analysis in Forex?
Video Transcription: What is Fundamental Analysis?
Hello again, we continue our trading academy project here on topratedforexbrokers.com with one of the most interesting sections of the project, namely .’What is fundamental analysis’. So I will start by splitting the screen in two. Let’s put the title here as ‘fundamental analysis.’ (He has the screen split and is adding Text above the line)
(0.29) You might be surprised to find out that not many traders fully understand what fundamental analysis is. First of all, what moves the market? This is the Forex dashboard, the market watch. The market is open, and eur.usd is 118 and here’s the Japanese yen and so on.
(0.49) What moves this market and why? Why does the “bid” and “ask” price move? Because this does not represent the supply and demand that is on the stock market for example. Because on the stock exchange, If you pick any stock, any symbol that you want, and if you buy enough of some shares, or you sell enough of some shares then you may actually influence prices.
(1.17) The problem with the Forex market, is that it’s so big and the liquidity is so huge and no one entity can influence the way the market moves. Therefore, why do we have these sort of spikes, for example like this, (drags crosshair down) and a spike lower on an hourly chart.
(1.41) Maybe even a spike higher like this (cursor at bottom left of screen). This high spike here turned out to be when the Federal Reserve of the United States announced the FOMC statement a week ago and from that moment the market simply consolidated.
(2.00) But this high spike came in one hour, what made the market move in that one hour? There are two reasons why the market moves. One is technical analysis. Technical analysis means, for example, they look at a chart, like this one (drags cursor diagonally), and they use either a trading theory or a technical analysis based on trend indicators, oscillators, volume ones or whatever they are.
(2.30) There are tons of trading strategies, or you can simply use fundamental analysis, So for Fundamental analysis, this is what you do. You interpret the world surrounding you, how do we do this? Look at these currency pairs.
(2.48) Pick one, USD/CAD now trades 1.2478, but it is a currency pair, the two currencies represent two economies, the United States Economy and the Canadian one. The currency pair will move or reflect the differences between the two countries.
(3.12) What kind of differences? First of all the economical differences. Namely, if the US economy performs better than the Canadian one, then you see the USD/CAD moving higher. On the other hand, if the Canadian economy performs worse, the USD/CAD will move high and so on.
(3.33) For economic news and fundamental analysis, the main driver is the economic news.(types economic news) We will cover the main economic news in our next video, but here we will talk about GDP or Gross Domestic Product (types GDP) the total value of goods and services, retail sales, inflation, interest rates, central banks discussing something etc. We will leave this one for now.(He leaves retail sales on the screen)
(4.22) These are the economic news and there is an economic calendar for it. The market expects the news to come and a then a sudden move happens. Even a sudden move like the one that I showed you hear with the FOMC (moves cursor) one week ago, even this kind of move is not possible due to human trading at the same moment of time when the news is released.
(4.48) What happens is that the algo’s or trading robots, the super computers that make the high-frequency trading. These algos will buy or sell as they are programmed to buy or sell at the same moment and during the same second or millisecond if an outcome gets out.
(5.011) For example, on the economic news you have inflation data, and inflation in the United States beats expectations it bullishes the dollar, hence the USD/CAD in our example will move higher, but it will move higher if indeed inflation beats expectation.
(5.30) It will move higher in the blink of an eye because all algo’s with super execution powers, will buy or sell at the same moment. Only after this, humans will come and join the party. This is why you have reactions when the economic news, which is part of fundamental analysis hit the wire
(5.58) What else? We have fundamental analysis, but how about macroeconomics (he types it), what does this mean? Economic news refers to each economy, in particular, the one in the United States, the eurozone economies, the Japanese economies and so on.
(6.24) When you consider macroeconomics, you look at the macro picture, the global conditions. In this world things are already divided, and we can not interfere in this kind of order, at least not as ordinary human beings.
(6.46) What kind of order? first of all, let’s take a shape to to discuss this.(He selects eclipse from dropdown) Here is the world, let’s change the colour on it. In the United States, represented here (Marks with a $) we have the USD, and the USD as we all know is the World Reserve Currency, let the United States share in this order.
(7.18) China, on the other hand, is the world’s manufacturer. (draws another eclipse) Everything can be manufactured in China. And I mean everything “quote-unquote”, most things around us, are manufactured in China. When China sneezes, the whole world trembles.
(7.38) When China doesn’t grow 7% or 8%, and the whole world wonders what will happen next. If we talk about commodities, we talk about Africa, we talk about Canada, and we talk about Australia and then where the demands move, and so on, there is a specific economic order in this world, and this Economic order influences Macroeconomics.
(8.02) Everyone is searching for a higher yield and as high as possible. When Interest rates in the United States, for example, were down to zero levels for years when quantitative easing 1,2,3,4 and so on took place, what happened with the world?
(8.22) Well, investors looked for other macro economics opportunities to invest in and of course to search for a better yield. So macroeconomics means that power over a specific region shifts towards a different region when conditions get better in a different region.
(8.49) But this is only another part of Fundamental Analysis. In Fundamental Analysis we have referendums (he types it), remember the Brexit vote, remember what happened in the UK when they decided to take a vote to see if the people wanted to leave the European Union and if so, then they would leave.
(9.20) Well they voted, and I caused a huge shift on the FX market, and that’s Fundamental Analysis. And take the elections, we have plenty of examples, we had the US elections last year in November (types US), and we had the French elections this year which caused the euro to get higher and to continue to rise from 1.06 to 1.20.
(9.45) We had the German elections quite recently and so on and so forth. These are elections, and this is still Fundamental Analysis (continues typing). One needs to take into account these kind of events. Why? Most of them happen over the weekend, and over the weekend you will never know how the market will open on Monday.
(10.11) There is a risk that your broker will not fill your order if you have a stop loss. If you have no market, then your broker will skip your stop loss.. Only now, everything we have discussed here is Fundamental Analysis. Part of Fundamental Analysis is everything that is not technical. Be it thunder, be it an earthquake, be it macroeconomic, economic news and referendums, a hurricane that can have a devastating effect on the economy. This is Fundamental Analysis and fundamental news and this is the reason why the market moves.
(10.52) Now, I may make it sound like it is the only thing that matters, but in reality, it isn’t. It represents only the reason why the market moves. Technical analysis gives it direction or the most likely direction of the market.
(11.12) But you need a catalyst, and that is Fundamental Analysis. Let’s move on with How to make the most of the economic calendar and the news that comes and hit the wires every day and month.
A financial product moves based on differences between supply and demand. As a rule of thumb, when there are more buyers than sellers, the price moves to the upside, and when sellers dominate a market, the price moves to the downside. The same is valid for the Forex market as well, only that here it is very difficult to assess the overall supply and demand level due to the fact that on this market there are so many transactions taking place on a daily basis that there is no entity to influence prices. What moves a currency pair, though? It is said that for a currency pair to move, there has to be a reason, and that reason is some fundamental factor. The fundamental analysis therefore represents the multitude of external factors that influence the two currencies that form a currency pair. These factors can be geopolitical, economic or even natural events. They are critical to trading, and one cannot take all aspects of them completely into consideration, as economic events can be monitored and predicted, but natural events, for example, can come as a total surprise.
What Does Fundamental Analysis Entail?
Fundamental analysis is carried out based on all of the external factors that can influence a currency or a currency pair, and can change the supply and demand balance. Fundamental factors are mostly economic factors, such as all the economic data used to analyse an economy in order to compare it with another one; but they can also be also political and geopolitical events as well as natural phenomena.
Economic Events That Influence the Forex Market
This is by far the most important and the most influential part of the fundamental analysis, and it takes one thing to master it: the economic calendar. This is free information grouped in the form of economic news from major economies, and offers traders a chance of knowing when news is going to be released, what its impact may be on a currency, and an indication of when the market is expected to make its next move. The economic calendar can be found for free with a simple Internet search, and most of the time it is offered by Forex brokers as well. In view of the above, a trader has no excuse for not knowing when a high-impact economic news item will hit the wires. All the economic news that makes up the economic calendar is grouped based on its importance, with high-impact news marked with the colour red, medium-impact news marked with orange, and low-impact items marked with yellow. The market does not move much when yellow or orange news hits the wires, but it travels aggressively on the rest. It goes without saying that the red events are critical, and on the economic calendar one will always have the previous value of an economic release and the forecasted value for the new one. A trader must prepare for these releases and must know about them in advance, as otherwise trading is only guessing, and will resemble gambling. If the actual release is going to be different from the forecasted one, the market will move, and this is what fundamental analysis is based on overall: events (in this case an economic one) that, at least for a while, change the balance between the supply and demand levels on a currency pair. The high-frequency trading industry is strongly involved in news trading, as trading algorithms buy or sell currency pairs based on the outcome of a news release when compared with the forecasted value.
Political and Geopolitical Events
Another important part of the fundamental analysis consists of political and geopolitical events that surround a currency pair. These events can change the balance between two currencies so aggressively that it is worth keeping an eye on what their impact might be. The recent referendum in the United Kingdom offers us the perfect example of a political event that changes the way currencies are valued. The Brexit vote for the United Kingdom to leave the European Union had a tremendous impact on the British Pound, such that it lost in value virtually overnight. It is not only the GBP currency pairs that moved, though, as correlations influenced trading as well. As mentioned in another article here on our Forex Trading Academy, correlations are very important, as some markets will move based solely on them. It doesn’t really matter if the news item refers to these currency pairs or not. As a consequence, the EUR/USD moved to the downside as well, as traders looked for refuge in the safety of the US dollar, the world’s reserve currency. In addition the JPY was bought for the same reasons, as well as the CHF. It is therefore clear that a political event, in this case a referendum, had a major impact on the overall currency market, as the GBP rebalancing influenced the value of all currency pairs. Other events in the same category are general elections in major economies, as well as war strategies and war-related events.
These are some things that are impossible to predict, but they are part of the fundamental analysis as well. These kind of phenomena, such as natural cataclysms, are so powerful that they disrupt the economic activity of a country/region. Examples of such events are floods, earthquakes, tsunamis, volcanos eruptions, etc., which happen unexpectedly and disturb the way an economy functions. All these have the potential to bring about large moves on the currency market.
These last two categories that are part of the fundamental analysis are the reason why the Forex market is not actually considered to be closed over the weekend. In principle, it is closed, but if elections happen over the weekend and the result is a surprising one, or a natural catastrophe happens, then a gap will form at the Monday’s opening. If the gap is big enough, there is no stop loss to help Forex traders, as brokers only fill an order if there’s a market. All of the factors above are show why fundamental analysis is critical to trading, and why keeping an eye on all these events is vital for correct money management technique.
Other educational materials
- Technical Analysis – What to Consider
- Moving Averages – Find Support and Resistance Areas
- How to Use Parabolic SAR to Buy Dips or Sell Spikes
- Leverage and Margin Requirements
- What is a Margin Call?
Recommended further readings
- “Fundamental analysis, future earnings, and stock prices.” Abarbanell, Jeffrey S., and Brian J. Bushee. Journal of Accounting Research 35, no. 1 (1997): 1-24.
- Short-sellers, fundamental analysis, and stock returns. Dechow, P.M., Hutton, A.P., Meulbroek, L. and Sloan, R.G., 2001. Journal of Financial Economics, 61(1), pp.77-106.