In the Forex market, there are 2 types of analysis commonly talked about: Technical analysis and Fundamental analysis. Technical analysis is the studying of price movements of different currencies. Traders analyse past price movements to spot potential trading opportunities. An example is using past data to find the trend of a currency pair. In this article however we will focus on Fundamental analysis. This refers to the analysis of political, social, and economic forces that may influence the demand and supply of currencies. It involves trading the news. Fundamental analysis relies on economic indicators which are very crucial in decisions regarding trading.
Economic indicators are reports disclosed by governments and private organisations that show the performance of a country’s economy. A country with a good economy has a high currency value while a bad economy is characterised by low currency value.
Some of the most commonly used Economic Indicators are as follows:
This is the value central banks charge to private banks for lending them money. A high-interest rate attracts a country’s foreign investment which in turn increases the demand for that country’s currency. A low-interest rate results in the depreciation of a currency’s value in the long run. For example, if the economy in Britain is growing, their financial assets will seem more attractive to foreigners. In order to acquire these assets, the foreigners will have to purchase them in British currency which increases the demand for the currency. To manage the growing economy, the central bank increases the interest rate to create a balance which is manageable and to also prevent inflation. The high-interest rate is a signal that the country’s economy is doing well.
Gross Domestic Product (GDP)
This is the total amount of goods and services produced by a country after a certain period. It indicates the country’s economic performance. A GDP increase shows that the economy of the country is growing which translates to the appreciation of its currency against other currencies. A declining GDP is an indication of a weakening currency.
This is the general increase in the prices of goods and services. Traders focus on inflation due to its impact on the prices of goods and services traded in the economy. Increase in inflation leads to decline in consumer spending which results in less demand of the currency thus weakening its strength. A decrease in inflation encourages consumer spending which strengthens the currency since there is money in circulation.
This is the difference between the value of exports and imports of goods and services. Exports increase the currency’s demand of the exporting country which improves the economy and value of the currency.
This is a report that shows the goods sold in the retail industry. It also indicates consumer spending habits. An increase in retail sales is beneficial to the value of the currency since its demand has increased.
Consumer Price Index (CPI)
CPI measures the changes in prices of consumer goods and services. It also indicates changes in consumer buying power through the effects of inflation.
Producer Price Index (PPI)
PPI measures the price changes received by producers for their products. It measures the cost incurred in producing goods.
This is the percentage of the labor force that is unemployed but is actively seeking jobs. A high percentage weakens the currency. This is because there is no income which results to decrease in consumer spending. A drop in the unemployment rate strengthens the value of the currency. This indicates a growing economy that is able to offer employment. There is an increase in income which results in more spending thus improving demand for the currency.
Non-Farm Payrolls (NFP)
This is the change in the number of employed people in the non-farming businesses. It is measured once every end month. An increase in NFP shows a growing economy since more people are employed. A decline in NFP shows a weakening economy.
Commodity Price Index
This indicates price changes for metals, oil, and minerals. A rise in the index increases the export which further strengthens the economy of the exporting countries. However, a decline in the index is beneficial to the importing countries due to lower prices.
This indicator reports on the number of residential buildings being built at a certain period as well as the house sales. High sales mean good economy while low sales indicate a weakening economy.
Choosing Currency Pairs
In general, some good currency pairs to trade using Fundamental analysis and Economic Indicators are EUR/USD, GBP/USD, AUD/USD, USD/CAD, USD/JPY, and USD/CHF. This is due to their high liquidity which is appropriate considering the volatility brought to the market by news events. Non-Farm Payrolls move an average of 140 pips, and Trade balance, Consumer Price Index, and Retail sales move around 60 pips so be careful with trading during these volatile time ranges. At the same time, the profits could be high due to the large price movement.
Analysis is The Key to Success
Using Fundamental Analysis is important in the Forex market and traders should study how it works. Knowledge of both Technical and Fundamental Analysis gives traders a competitive edge in the market. All the best brokers provide traders with an Economic Calender which you can consult when waiting for Economic Indicators throughout the year which can help serve as a guide in decisions you make when you trade.