Having knowledge on how to do a complete and thorough fundamental analysis of the currency market, can be a very powerful asset for any trader out there. Some of the great investors like Warren Buffet have made a lot of fortune by solely depending on fundamental analysis. So it goes without saying that we all need fundamental analysis in our trading.
So what is fundamental analysis anyway?
Fundamental analysis involves evaluating the economic, political and social forces which influences the supply and demand of a currency, stock or other assets. If all these forces are good in a certain country, then you should expect its currency value to increase. If a country has a bad economy and unstable political system, then you expect its currency value to decrease. This is in simple terms how you explain fundamental analysis. Now let us dive deeper and look at a step by step guide to fundamental analysis.
Step by step fundamental analysis guide
There are basically two very important analyses to carry out when doing a fundamental analysis of the currency market. These are; the macro-fundamental analysis and the micro fundamental analysis.
1. Do a macro-fundamental analysis
Here, you should be asking yourself, what are the big economic factors that affect the currency market? The following are some of the factors you will need to look at.
The fiscal policies
We can define these as, the rules and regulations that have been put forward by the government with regard to taxation and spending. The policies are usually aimed at maintaining price stability and economic growth. However, they can be used to influence business activities in the country. The government, for instance, may choose to increase taxes so that people have less income and therefore less money to spend. This will of course reduce business activities and affect the economy of the country. This may result in the weakening of the country’s currency and hence a factor to always consider when doing fundamental analysis.
The monetary policies
Here we are simply talking about money and other factors related to money. The central bank is always in charge of managing interest rates and supply of money in a country. This helps control inflation. An increase or reduction of money supply will drastically affect the currency market and therefore you should be on the watch out for such factors.
Elections are not carried out monthly or yearly, but anytime they are there, you should expect volatility in the currency market. This is usually because there is a lot of tension and uncertainty within the country, causing fear among investors.
If a highly ranked rating agency like Fitch Ratings or Moody’s downgrade a country’s performance, then this will not go well for the economy of the country.
The Bond market
As an investor, you should be aware that the bond market has a long term effect on the trends of currencies. People who speculate the market often use information from the bond market as a leading indicator for future price changes.
2. Do a micro-fundamental analysis
This type of analysis focuses on factors such as company actions, economic releases, activities of the workforces and many others.
If you trade in the currency market, then you will need to keep up to date with news releases and especially if you trade the lower time frame charts. You can do this by following channels such as Bloomberg. This will at least ensure that you are not caught off guard by major developing news.
Economic releases are known to cause an instant spike in the currency market. Lucky for all traders, such releases are usually scheduled on certain specific days. For this reason, you should ensure that you check your economic calendar every day. One of the major economic releases traders look to take advantage of, is the non-farm payroll report commonly known as NFP.
The NFP is a report released every first Friday of a new month giving information about employment in the US. An increase usually means that the US economy is doing favorably and hence the dollar is expected to strengthen. This would in most cases, cause an abrupt rise in currencies such as USD/JPY and a fall in EUR/USD. A decrease would mean that the US economy is not doing well and hence the dollar will be expected to be weaker compared to other currencies. You can keep up to date with such releases through plartforms like Forex factory, Forex live and FX Street.
Government officials’ comments
Whether it’s the president or any other high ranking government official, a comment that affects the country can tremendously affect the currency market. For example, if a president comments that his government is looking to further better relations with another country, then we expect some changes in the currency market especially in currency pairs which these countries are involved.
3. A general rule of thumb
You expect a country to have a favorable economy if it has rising employment, higher disposable incomes, rising household demands, increasing business production, increased consumer spending, rising sales and great wages for workers. So whether you are trading healthcare stocks or the EUR/USD, these factors should help you make a well-informed decision.
By following the above steps, you can be able to do a great analysis of how the economy of a country is performing. This will come in very handy when executing trades. News and economic releases can be a gold mine if you know how to incorporate the information into your trading.