Fundamental analysis is studying the forces that influence the economy.
For a good forex strategy, fundamental analysis is indispensable. Look at the
average forex economic calendar and you will be faced with an extensive buffet
of figures that are important for the Forex. A small selection:
- Unemployment Rate
- Building Permits
- Oil Inventories
- CPI y / y
- CPI underlying m / m
- Housing Starts
- Fed Chairman Speaks
Of course,
the actual list is much longer, and those of us who are not economists but
mathematicians will probably throw the towel in the laundry basket and run
towards the nearest technical indicator.
You can
and may, of course, but without keeping a close eye on these figures, you still
remain a boxer who fights with one arm. (in this case the technical arm).
Moreover, it is all so difficult not once you have a reference framework. After
all, you do not have to think up or calculate those figures yourself, you just
have to be able to interpret them.
Most of us
also act mainly in the short term when it comes to Forex -intra day, day- and
an important rule of thumb is: the shorter the term you act on, the more
important the news of the moment will be.
If everyone
expects the US GDP (Gross Domestic Product) to increase by 5% and it turns out
to be 8%, this will almost certainly have an effect in the shorter term, but
whether the effects are still noticeable four weeks later is still but very
questionable.
The 4 Fundamental Themes
The 4 themes that drive the currency markets:
- Economic growth
- Interest rates
- Trade balance
- Political stability
Economic growth
This is a
logical course. The strength of a national currency is determined primarily by
the strength of the economy in which it operates. And just like quarterly /
year figures of a company say a lot about the economic health of that company,
so say quarterly / year figures of a country much about the economic health of
that country. The forex market therefore focuses primarily on the economic
strength of national economies.
However,
90% of the Forex traders target a period shorter than 2 days, so their message
is likely to have an effect on their EUR / USD or GBP / USD position.
The
notorious / famous (denomination depending on whether you are a capitalist or a
socialist?)) Investor Warren Buffet has held a Long EUR / USD position for
years, where he has been considerably criticized in 2005 - during a hefty EUR /
USD downturn. However, if you look at the price development over the previous
years (from 0.8 USD in 2002 to 1.35 USD in 2005 to 1.57 USD in 2008) it is a)
clear that WB is not such a rich stinker for nothing and b) it is clear that WB
will not skip its lunch because Consumer Confidence in the Eurozone has
decreased by 0.5%; and c) that he has more confidence in the EU economy than in
the US (but that aside).
For our
hyperactive day traders, however, the world is running a lot faster ..... :)
So if the GDP of Germany (the largest economy in the
Eurozone) has increased by 1% MORE than analysts had expected -with constant
inflation- the value of the EURO is likely to rise. On the one hand because
more companies will want to invest in the German economy (as a result of which
the demand for the currency really gets bigger) and on the other hand because
fx traders will speculate on an increase of the price (speculative value).
Important Indicators for economic growth include: GDP q /
q and GDP y / y (quarterly and annual figures Gross Domestic Product, or BNP),
Unemployment rate, non-farm payrolls, Industrial Production and consumer
confidence.
Interest
rates
Anyone who has ever had economics in high school knows
that economies develop in a cyclical movement, or in a rising and falling
trend. The peaks and troughs of these trends alternate more often in the short
term than in the long term (for example over a period of 50 years).
National governments have simply said two tasks in the
area of macroeconomics:
1) Stimulate
growth in GNP
2) Control
cyclical movements.
Point 1 is logical.
The greater the growth of GNP, the richer the country, the more prosperous the
citizens (in general, then).
Point 2 is
also logical, but is less obvious. That we do not like economic depths
(low-cyclical, recession) is clear, but what is wrong with a high-level
economy? That comes down to the saying: What comes up, must come down. A high
economic situation that can not be controlled can lead to an overstressed
economy. Shortages on the labor market, ever higher wages, ever higher prices
(the infamous 'wage-price spiral'), increasingly large money market (everyone
wants to invest in that good-running economy) and then finally ... The Great
Turnover.
Sentiment is turning, there is enormous overproduction,
people have to be fired, applications for benefits (and therefore costs for
governments) are increasing explosively, investments are falling, the economic
cycle is on the way down.
No one benefits from this, and so the government aims to
control the cyclical movement of its economy: less high peaks, less deep
valleys.
An important means for this is the interest rate. This
concerns the interest charged by the Central Banks * (such as 'De Nederlandsche
Bank', 'Deutsche Bank', 'Bank of England') to the commercial banks when they
want to borrow money from the Central Bank. This is important, because if it
becomes more expensive for commercial banks to get extra money, it will also be
more expensive for investors to get money, so growth will weaken. Conversely,
investments will increase when it becomes cheaper for banks to borrow money
from the Central Bank.
When a Central Bank raises the interest on its currency
(currency), this means a) something about how the Central Bank thinks about the
state of the economy and, above all, whether the growth is stimulated or
weakened. When the interest rate is raised, the money market becomes narrower
(after all, it becomes more expensive to borrow money) and the value of the
currency generally increases, with a reduction the money market increases and
the value of the currency generally decreases.
Exception
An important exception to this is when a Central Bank
raises interest rates to curb inflation instead of curbing the high-level
economic situation. This suggests that the money market is too large (hence the
prices are constantly rising) and the benefits of the higher interest rates for
the currency's power are now being nullified by the fear of further currency
devaluation.
A good example of this is the interest rate increase of
the ECB in June 2008 (from 4% to 4.25%) that was not received with a climb of
the EURO against other currencies but with a decline, because it was clear that
the interest rate was raised to curb high inflation (4%).
But in general it is therefore:
interest up = currency up on
the Forex
interest down = currency down
on the forex
Trade Balance (Trade Balance)
Suppose the US buys $ 100 billion more goods from the
Eurozone than it sells. To buy these goods, the Americans need Euros. So they
actually buy in for 100 billion dollars. Their trade deficit ([Trade Deficit]
ensures that the Euro rises in value against the dollar.
The reality is often more complex than this example (for
example, from American companies in the Eurozone that export goods to the US),
but it is important to understand that the value of a currency may decrease if
the trade balance deficits of a increase land. So if there is a figure about
the US economy about the Trade Balance, which is expected to be + 2% compared
to the previous period, while the actual figure turns out to be -3%, that is a
(strong) indication that the USD will decrease in value.
Political stability
Much more than stock markets, the FX market is influenced
by politics. This is also understandable, since on the forex market is
"traded" in national economies, not in individual companies.
Political instability can damage economic growth and
therefore also the currency in question. Especially a corruption scandal can
seriously damage the value of a currency.
A good example of this is the decline of the CAD against
the USD in the summer of 2005 - despite rising oil prices, something that the
Canadian currency usually benefits from - because the ruling Liberal Party was
embroiled in a political scandal. After a vote of no confidence was rejected
(difference of 1 vote!) The CAD climbed up again .....
Conclusion
Your natural familiarity may also be more with the
Technical Indicators (which we will discuss later), but it is still smart to
keep an eye on these four fundamental keys. An example of this is the situation
in 2004, when the USD made new lows against the EURO despite several positive
and surprising economic developments in the US economy. When the technical
indicators began to see weakness in the EUR / USD pair, technical traders who
had watched the fundamentals were able to step in with great confidence and
benefit from the dollar rally that followed.
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