At its simplest, fundamental analysis examines economic and political conditions which could affect foreign currency prices and Forex traders who use fundamental analysis rely upon news reports for information on a whole range of things including, growth rates, economic policy, inflation and employment rates.
Basically, fundamental analysis provides an overview of currency movements together with a broad picture of economic conditions that could well alter the value of a specific currency. With this picture in mind, foreign currency traders will then often go on to use technical analysis to then plot entry and exit points into the market and to augment the information gained through fundamental analysis.
The Forex market is much like other markets and is affected by the forces of supply and demand, which are themselves affected by economic conditions. Two economic factors affecting supply and demand are the strength of the economy and interest rates and the strength of the economy is itself affected by foreign investment, the gross domestic product (GDP) and the country's balance of trade.
A whole variety of economic indicators are released by governments and by other sources and are usually held to be good measures of the health of an economy which are followed by all sections of the investment market. The majority of economic indicators are released once a month although a few are issued more frequently and normally weekly.
Two of the most important fundamental indicators are international trade figures and interest rates, but other particularly useful indicators include the, consumer price index (CPI), producer price index (PPI), durable goods orders, purchasing manager's index (PMI) and retail sales.
Interest rates are a very important indictor as they can have either a weakening or strengthening affect on a currency. For instance, high interest rates could attract foreign investment which strengthens the local currency, while stock market investors generally react to increases in interest rates by selling in the belief that higher borrowing costs will have a harmful affect on many companies. Large-scale selling by stock market investors can quite often cause a downturn in the stock market and the national economy.
International trade indicators are also especially important for the Forex trader. A trade deficit, indicating that imports have exceeded exports, is normally seen to be an adverse indicator as money flowing out of the country to purchase foreign goods could well have a devaluing affect on the currency. However, fundamental analysis will also indicate the expectations of the market and these will generally determine whether a trade deficit is unfavorable. For instance, it might be the case that a county usually operates with a trade deficit and that this fact has already been factored into the price of its currency. In general, a trade deficit will only affect currency prices where they are higher than the market would usually expect.
Every country has its own set of economic indicators (currently there are in the region of 28 major indicators in use within the United States) and these have a strong influence on financial markets. As a result, Forex traders need to be conversant with them and examine them carefully when they are preparing their trading strategies.
Fortunately, for traders working on the Internet, many sites now provide a wealth of up-to-date information, but it is up to individual foreign currency traders to take this information and then apply fundamental analysis to it in order to formulate their trading decisions.
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