Trading in financial markets has become more widespread than ever thanks to the availability of the Internet and online trading platforms. The technological advances have increased the number of market participants and the available pool of investment money as a result.
Nevertheless, enhancing one’s bottom line continues to be the primary goal in this age old game of trading, Analyzing the market fundamentals, whether the underlying asset is a stock, bond, commodity or forex currency pair remains a cornerstone of how trading decisions are made for many professional and retail operators.
For those who are not purely technical, performing sound fundamental market analysis before initiating a trade can make a significant difference in the overall success of a trading position. And this is especially true for longer term position traders.
For example, knowing how a currency pair may react to a major central bank decision before it is released, and what the market is expecting to happen by going through a basic forex fundamental analysis process can be very helpful to a currency trader when establishing or liquidating a position.
What is Fundamental Analysis?
Fundamental analysis is one of two main methodologies for evaluating and forecasting movements in currency exchange rates, as well as for the prices of securities, commodities or any other publicly traded asset or financial derivative.
The other primary method used by traders is known as technical analysis, which focuses on market observables like the exchange rate or the price of an asset, the volume traded and open interest.
The basic skill involved in fundamental analysis in forex trading requires an analyst to determine how a currency will react to macro-economic events, central bank monetary policy shifts, and political and
social news from the currency’s nation of origin when compared to the other currency in a currency pair. In the case of a common regional currency, such as the Euro, the analysis of each member state in addition to the entire regional economy as a whole is required to make an accurate fundamental evaluation of the currency.
Basically, currency pairs tend to react sharply to the release of economic data and current geopolitical and local news events, especially when the results differ significantly from what was originally expected by a consensus of market participants.
This makes performing a fundamental market analysis of economic releases and events and their effect on currencies valuable when determining the direction of the market and the level of future exchange rates.
Fundamental Analysis Tools
The most useful tools for fundamental analysis consist of the economic calendar, the financial news media, and historic fundamental data.
The economic calendar informs the trader on the scheduled time and date of the release of major and minor economic data that can have an effect on the nation’s currency.
Trading news broadcasts from the financial news media keeps the market informed of any major economic or geopolitical developments that could directly or indirectly affect the market.
Historical fundamental data can be useful to determine trends in fundamental indicators,
as well as to analyze how a currency might react to a specific economic release after examining its behavior in the wake of a previous release or central bank rate decision, for example.