Forex fundamental analysis is simply a method of using the “fundamentals” in a certain market to gauge how the currency price will be affected. These are some of the factors to consider in fundamental analysis:
* Economic conditions
* Political environment, particularly with regard to stability
* Interest rates
* Supply and demand for the currency
* Government policies
* Historic performance of the currency
* International trade position — deficit or surplus
* Consumer price index (CPI)
* Gross domestic product (GDP)
* Cost of producing goods (PPI)
Who watches these fundamentals and releases the information about them? The central banks of each country are responsible for the economy of the country, so they carefully watch the factors that affect it: the fundamentals. The factors are announced by the central banks regularly, sometimes monthly but often weekly, and the exact time of these announcements is known in advance. Another term for these factors is “indicators”, which you will hear often in forex trading.
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You must understand that these indicators are always pretty much expected by the market even before the announcement. Forex traders position themselves accordingly in the market. Indicators that conform to these expectations will cause little effect on the market.
On the other hand, if these expectations are not what actually occur, currency prices will definitely move. That’s what fundamental analysis is all about, and lots of forex traders use this information exclusively in their trading. I personally, however, recommend a combination of fundamental and technical analysis.
The European Union’s ECB, the U.S. FED, the U.K. BOE and the Japanese BOJ have the most influence of all the central banks. Forex traders are wise to pay attention to these bodies in their trading.
As might be expected, U.S. indicators have the biggest impact on the forex market. The ECB indicators have less impact, except when they are much different from what was expected. Two of the major economic drivers that affect the forex market are interest rates and inflation, so listen carefully when knowledgeable financial experts talk about them.
Forex fundamental analysis is made all the more complicated because accurate measurement of the variables and their relationships is difficult. Estimates are mostly based on historical experience. What is happening in the world, such as major political events or wars and other international catastrophes, can also cause certain assumptions to be made. These may or may not come about as anticipated, but it can take time for the markets to adjust to the reality.
The forex market is, like life itself, subject to the law of supply and demand. If other factors have caused the supply of a currency to decrease but the demand remains at the same level, the price will increase again. The opposite also holds true: if demand stays the same while prices have increased, eventually the price will decrease.
This is the basis of forex fundamental analysis.
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