What is Fundamental Analysis? How can you do fundamental analysis in forex market? When taking trade decisions, it’s important to do both fundamental and technical analysis. So why is fundamental analysis so important? I will try to explain to you in this article.
What is Fundamental Analysis?
As you know, there are fundamental factors that determine prices in all trade elements. Forex market is also a capital market based on foreign exchange trading. In FX market, you are able to trade various currencies and commodities. Just like the other markets, prices are determined by the supply-demand relationship in the forex market.
Demand means desire of buying and supply means the number of products or services on the market. As an economic rule of thumb, when supply is more than demand, prices tend to decrease. On the other hand, when demand exceeds supply, then the prices will tend to increase. Therefore, analyzing all the economic, political, social developments and news that may affect supply and demand balance to predict the trend of prices is called fundamental analysis.
Fundamental analysis is indeed one of the essential tools for predicting the future prices in the forex market. However, there is another method of analyzing the markets which is called technical analysis which I will write an article about later on.
Fundamental Analysis or Technical Analysis?
There is a constant debate in the world of investment; is fundamental analysis or technical analysis giving more successful results? In my opinion, in order to become a successful trader, you need to do both fundamental and technical analysis. In forex markets, it’s very difficult to predict the direction of the prices in the future. In order to increase the possibility of profitable trades, you must use techniques of both fundamental analysis and technical analysis.
How to do Fundamental Analysis in Forex?
In order to do fundamental analysis in the forex market, you need to follow recent developments about the currencies that you are trading. For example, when US central bank Fed hikes interest rates, dollar demand in the market will increase. Thus, US dollar will start gaining strength. Or when Bank of England cut rates, traders expect British Pound (GBP) to lose value. As you can see, interest rate decisions of every central bank cause change on the prices of the relevant currencies.
Let’s continue with another example. In order to do successful fundamental analysis about USD dollar, you need to follow economic releases like non-farm employment change, unemployment rate, GDP growth, inflation rate, interest rate decisions, and central banker speeches. The easiest and quickest way for a trader to follow these economic data is the economic calendar. You can check the economic calendar from websites like www.investing.com or www.forexfactory.com for free.
Thus, you won’t panic when prices start to move quickly, because you will already know the reason behind it. Fundamental analysis will also give you a more comfortable investment psychology. This is also very important for risk management.
However, it’s not easy to do fundamental analysis. It requires some experience to do it. For example, you can think after Fed raise interest rates, dollar will rise. But it’s not always the case. If a rate hike from Fed is widely anticipated, then USD may not gain strength following the decision.
In addition to economic data and central bank policies, domestic and international politics may have a big impact on the price of the currencies. A political instability or uncertainty such as general elections may cause a currency to lose value. Also, in the case of geopolitical risks such as war, investors tend to avoid the related currency and thus the currency depreciates.