What is
it exactly and will I need to use it? Well, fundamental analysis is the study
of fundamentals! That was easy, wasn't it? Ha! Gotcha!
There's
really more to it than that. Soooo much more.
Whenever
you hear people mention fundamentals, they're really talking about the economic
fundamentals of a currency's host country or economy.
Economic
fundamentals cover a vast collection of information - whether in the form of
economic, political or environmental reports, data, announcements or events.
Even a credit rating downgrade qualifies as fundamental data and
you should see how Pipcrawler turned this news into a winning short EUR/USD trade.
Fundamental
analysis is the use and study of these factors to forecast future price
movements of currencies.
It is the
study of what's going on in the world and around us, economically and
financially speaking, and it tends to focus on how macroeconomic elements (such
as the growth of the economy, inflation, unemployment) affect whatever we're
trading.
Fundamental Data and Its Many Forms
In
particular, fundamental analysis provides insight into how price action
"should" or may react to a certain economic event.
Fundamental
data takes shape in many different forms.
It can
appear as a report released by the Fed on U.S. existing home sales. It can also
exist in the possibility that the European Central Bank will change its
monetary policy.
The
release of this data to the public often changes the economic landscape (or
better yet, the economic mindset), creating a reaction from investors and
speculators.
There are
even instances when no specific report has been released, but the anticipation
of such a report happening is another example of fundamentals.
Speculations
of interest rate hikes can be "priced in" hours or even days before
the actual interest rate statement.
In fact,
currency pairs have been known to sometimes move 100 pips just moments before
major economic news, making for a profitable time to trade for the brave.
That's
why many traders are often on their toes prior to certain economic releases and
you should be too!
Generally,
economic indicators make up a large portion of data used in fundamental
analysis. Like a fire alarm sounding when it detects smoke or feels heat,
economic indicators provide some insight into how well a country's economy is
doing.
While
it's important to know the numerical value of an indicator, equally as
important is the market's anticipation and prediction of that value.
Understanding the resulting impact of the actual figure in
relation to the forecasted figure is the most important part. These factors all
need consideration when deciding to trade.
Phew!
Phew!
Don't
worry. It's simpler than it sounds and you won't need to know rocket science to
figure it all out.
I suggest you visit Pip Diddy's daily economic roundup every day so that you can stay in the loop with the upcoming
economic releases.
Fundamental analysis is a valuable tool in estimating the future conditions of an economy, but not so much for predicting currency price direction.
This type
of analysis has a lot of gray areas because fundamental information in the form
of reports releases or monetary policy change announcements is vaguer than
actual technical indicators.
Analysis
of economic releases and reports of fundamental data usually go something like
this:
"An
interest rate increase of that percentage MAY cause the euro to go up."
"The
U.S. dollar SHOULD go down with an indicator value in that range."
"Consumer
confidence dipped 2% since the last report."
Here's an Economic Report, Now What?
The
market has a tendency to react based on how people feel. These feelings can be
based on their reaction to economic reports, based on their assessment of
current market conditions.
And you
guessed it - there are tons of people, all with different feelings and ideas.
You're
probably thinking "Geez, there's a lot of uncertainty in fundamental
analysis!"
You're
actually very right.
There's
no way of knowing 100% where a currency pair will go because of some new
fundamental data.
That's
not saying that fundamental analysis should be dismissed.
Not at
all.
Because
of the sheer volume of fundamental data available, most people simply have a
hard time putting it all together.
They
understand a specific report, but can't factor it into the broader economic
picture. This simply takes time and a deeper understanding of the data.
Also,
since most fundamental data are reported only for a single currency,
fundamental data for the other currency in the pair would also be needed and
would then have to be compared to get an accurate picture.
1. If you're
too busy to go through a bajillion news reports and economic data, don't fret.
Our resident economic guru, Forex Gump, got yo back covered! Make sure you read
up on his regular economic analysis on his Piponomics blog.
As we
mentioned from the get-go, it's all about pairing a strong currency with a weak
one.
At this
point, you're probably still waiting for the answer to "Will I ever need
to use fundamental analysis to become a successful trader?"
We
totally understand that there are purists on both sides.
Technical analysis seems to be the preferred methodology of short-term traders, with
price action as their main focus.
Intermediate
or medium traders and some long-term traders like to focus on fundamental analysis
too because it helps with currency valuation.
We like
to be a little crazy by saying you should use BOTH!
Technically-focused
strategies are blown to bits when a key fundamental event occurs. In the same
respect, pure fundamental traders miss out on the short term opportunities that
pattern formations and technical levels bring.
A mix of
technical and fundamental analysis covers all angles. You're aware of the
scheduled economic releases and events, but you can also identify and use the
various technical tools and patterns that market players focus on.
1. I have a
couple of trade examples for you showing how the perfect blend of fundamental
and technical analysis results in huge profits. Check out Cyclopip's huge win on
EUR/JPY and Happy Pip's 115-pip
profit on NZD/USD.
There's
your answer!
Happy?!
In this
lesson, we'll discuss the major fundamental factors that affect currencies.
These are interest rates, monetary policies, and market-moving economic
reports.
As I mentioned earlier, Pip Diddy's daily economic roundup is a great source of economic updates. Combine that with Forex
Gump's in depth Piponomics articles and
fundamental analysis will be a breeze!