If you enter the international financial markets you will see phrases like Forex fundamental analysis. This can be a basis for you becoming interested in this field. Financial markets just like any other business platform need constant monitoring and control.
There are two types of analysis in the Forex financial market; one is technical, and the other is fundamental. These two analyses are somehow counter to each other, meanwhile supplementary. Because none of them can be practical for a professional trader. Another analysis has recently been added to these two types, which is called the sentimental analysis of the market. This article aims to define the fundamental analysis, its importance, and its critical indexes. Stay with us up to the end of it!
A simple definition of the fundamental analysis of Forex
Unlike technical analysis, which involves examining charts and graphs to identify patterns and trends, fundamental analysis deals with much more complex concepts. Economic data such as interest rates and economic news are used in such an analysis. Generally, when conducting fundamental analysis, economic, political, and social factors must be considered, all of which are effective regarding the currency.
Paying close attention to this analysis of Forex, we realize how crucially important it is. This is to explain why: what do we deal with in Forex trades? Yes, it is true, currency rates. Then, what factors determine the rates? They are supply and demand; thus, no accurate predictions about the market can be made unless we determine the amount of supply and demand according to the fundamental analysis indexes. Using supply and demand as a determining index affecting the prices initially seems to be quite simple. The challenging part is when we must identify all the factors impacting supply and demand and then present an appropriate analysis accordingly.
How to begin conducting the Fundamental Analysis
A simplistic answer is to decide what economies are good and what are bad! Because every factor refers to the currency of the country. We should be able to explain why some phenomena and occurrences like the increase in the unemployment rate affect the economy and financial politics of a country. As a result, finally, the demand for the currency of a country begins to change.
This analysis demonstrates that if there are good prospects for the current or future economy of a country, its currency must be empowered. If the economy is thriving and prosperous, enterprises and more foreign investors are willing to invest in different sectors of the country; and this means a higher demand for the currency for purchasing its assets.
The difference between the price and the real value of an asset
The main assumption of Forex’s fundamental analysis is that the price of an asset can be different from its real value. Therefore, different markets can sometimes value an asset at the wrong price. Fundamentalists state that even though there can be wrong pricing in the short term, assets will always go back to their real price. The ultimate goal of analysis using this method is to discover the real value of an asset, compare it to the current price, and find trading opportunities.
This also shows the key difference between fundamental and technical analysis. While Forex’s technical analysis hardly pays attention to anything but the current price, fundamental analysis investigates everything except the current price. While this is true that fundamental analysis is not the best tool for short-term investing for a trade it is the fundamental factors of Forex and their analysis that answer what is going to happen in the long term.
What are the indexes of fundamental analysis?
We need to examine the main indexes of the fundamental analysis of Forex to determine the overall strength of a country`s economy. The indexes affect the currency rates, and their consideration enables us to predict the rate in the coming days.
Economic indexes
These are the reports published via the news or other media by a government or an organization. The economic performance of a country is demonstrated in these reports; in other words, these are the tools used for determining how sound and robust the economy of a country is. For instance, the unemployment rate and the statistics regarding housing are examples of such reports, which might not be given adequate attention. However, any index tends to serve a specific purpose and could be equally important.
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The GDP
The Gross Domestic Product is the broadest economic factor of a country and indicates the whole value of the market and all of the goods and services produced in a year. If the GDP rises in a country, it signifies that the country has a sound economy and can increase the value of its currency.
Because the GDP is a lagging economic index, a majority of traders primarily focus on the reports published months before the finalized data of GDP. These reports are called the initial reports. Analyzing these reports results in considerable fluctuations. The Gross Domestic Product to some extent resembles the gross profit margin of a public company because both are considered internal growth factors.
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Consumer Price Index (CPI)
This index indicates the changes in consumer goods prices made by the consumers and is regarded as one of the key inflation indexes. As inflation control is the ultimate responsibility of central banks, any changes applied to consumer prices can affect the monetary policies of a country. Comparing the consumer price report with the export report of a country enables us to assess loss and profits in terms of goods or services; because the export prices are usually determined in proportion to whether a currency is strong or not.
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Retail Sales
A retail sales report determines the amount of input in all the retail sales markets in a country. This report can be utilized to predict the performance of more important lagging indexes and economic evaluation.
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Producer Price Index (PPI)
The Producer Price Index measures the change in the prices domestic producers have received over time. This index is used to evaluate the amount of inflation at the wholesale trade level, and to measure that, many industry-based and goods categorizations PPI are used. As this index impacts the currency of a country, it is of paramount importance. If the PPI is high, it means that the country is faced with consumer inflation, and vice versa.
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Purchasing Managers Index (PMI)
This index involves the activities of purchasing managers and is important because the managers are the first individuals to be informed about either increases or decreases in future productions. As a result, examining such an index demonstrates the strength of the production sector.
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Recruitment reports
Items of information such as unemployment rate, job seekers, salaries, and other data regarding jobs can be found in such reports.
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Balance of trade
It refers to the balance between imports and exports in a country that considerably affects the demand for the country`s currency. If this balance indicates a deficit, it means that the country has more exports than imports; if a surplus is indicated, it means the imports are more than the exports.
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Checking accounts
A checking account refers to the cash transactions of a country. If this index indicates a surplus, it means that the value of foreign assets is more than its debts and vice versa.
Geopolitical impacts
After assessing the importance of economic indexes in the Forex fundamental analysis, we should move on to the geopolitical events and their importance to fundamental traders. According to Wikipedia, geopolitical considerations refer to the study of geographic (human and physical) impacts on politics and international relations. This study, however, includes the relations between the countries as well and is related to the political strength of a country, considering its geographic ambiance. Such geopolitical incidents include wars, elections, changes in power, and natural disasters. In the following, they are all outlined.
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Wars
Either the beginning or the end of a war in a country impacts the exported currency as well as the other countries involved. Not only do wars affect currencies, but they impact the prices of goods and other assets of the countries involved in a war. This impact can determine all the economic indexes of a country.
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Elections
This is one of the geopolitical events that can considerably change the value of a country`s currency. Elections might result in a change of regime or the exclusion of a country from a particular zone. As a result, many changes can be made to prices and currencies. Elections can also be referred to as determining factors regarding the government`s debts, the amount of taxes, and other economic elements.
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A change in power and regime
If people in society take steps towards a regime change or in case of forced change and coup, the value of its currency will be subject to change.
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Natural disasters
If floods and earthquakes strike a country, it requires the restoration of money to provide support for people who are involved in the disasters. As a result, the value of its currency rises. It is noteworthy that this increase is temporary and subject to changes and if the country is compelled to cope with such incidents for a long time, that could be harmful to its economy.
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Economic news
Many Forex traders use the economic news when beginning or ending short-term trades. Because some crucial items of news can create two-way fluctuations, professional traders tend not to begin trading before the announcement of economic news. However, these fluctuations in the course of announcements are likely to create some opportunities for traders and cause them to take advantage of a phenomenon named “market reform”.
Those traders who intend to opt for long-term investment in Forex, tend to analyze the news within a longer period to identify the most appropriate prospective positions according to the economic, social, political, and monetary policies of a country.
The sentiments and emotions of the market
One of the indexes of the fundamental analysis in Forex is the emotions of the market. Because such a market has many fluctuations, emotions tend to assume a critical role and must be considered when providing a fundamental analysis.
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Risk and risk aversion
When everything seems to be rewarding, and positive, and there are prospects for a promising future in the global market, traders are more willing to take risks. In this case, they are likely to choose the assets which, hypothetically in other cases, they would not be able to take unnecessary risks. Here, it can be said that there is a trend toward risk-taking.
On the other hand, the political and economic climate of a country might create a sense of pessimism and distrust regarding the market and investment. In this case, traders adopt the risk aversion strategy and opt for less risky assets. Thus, the market is coping with the risk aversion crisis.
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Financial polls and surveys
Public companies tend to publish reports on the market`s sentiments each month. Part of these surveys includes the consumer and purchase manager trust index, the impact of which can be evaluated on the market by the traders.
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Sentiment index
As it can be understood, it is linked to the emotions of traders. Its reports include the commitment of traders in different situations in the market. In addition to that, there are also reports on the fluctuation index, which indicates the level of fear in investors, and the CBOE Equity Put/Call report indicating whether investors prefer bullish purchases to bearish sales or vice versa.
When to use the Fundamental Analysis?
As you know, there are two types of technical and fundamental analysis in the Forex market, although sentiment analysts have recently added sentimental analysis to the two main types. It is almost impossible to provide a definite answer to the question of whether to use or when to use technical or fundamental analysis because these two are supplementary and either of them in isolation is impractical.
Suppose that you are in the middle of a trade and according to the technical analysis everything seems normal but a few hours later everything changes, and you are struck by the lightning of loss. Then you realize that in recent hours some news has been published affecting the stocks. Thus, you should not merely adhere to the technical analysis to the exclusion of the fundamental analysis.
Advantages of using The Fundamental Analysis of the Forex Market
The numerous advantages of using the Forex fundamental analysis lead to you achieving futuristic success and also gaining a bird’s eye view of the financial politics of the country. This is opposite to the structure of technical analysis.
It is an important pillar of long-term investment
If you want to invest long-term in markets like Forex, you will need fundamental analysis. If you can’t control the state of a country in the long run how can you invest continuously? This will not be possible without a good analysis methodology.
Complete understanding of changes in the market
The important thing about Forex’s fundamental analysis is that you can control changes in the political world and use them to fully understand fluctuations. One of the most important differences between Forex fundamental analysis and technical analysis is that you have no information about the day-to-day happenings of the economic and political world.
Helping to identify great opportunities
If you want to achieve amazing financial success in the long run you can look at how a country changes over time and control its currency with it. This is the most important miracle of Forex’s fundamental analysis.
Problems and Disadvantages of Forex Fundamental Analysis
The important point that you have to know is that disadvantages will always be part of your work, you just have to be aware not to enter them and have a good understanding of what is essential.
A wide variety of information
Sometimes in Forex fundamental analysis, the data become so vast that they become a problem. If some of these data can be in paradox with itself you can see this problem even more clearly. It is important to note you also need great capability and incredible energy to be able to invest in the area.
Time-consuming
Sometimes a news spread can affect the market so fast that you won’t have enough time to analyze it. This can even lead to losses in your next trades. And as such, sometimes you won’t get good answers from fundamental analysis.
The bias of the Trader
This is a common defect in both technical and fundamental analysis. Biases and insisting on past events are some of the greatest defects in these analyses. A lot of beginners will struggle with this.
Conclusion
The fundamental analysis and its indexes in the Forex market have been explained in this article. Generally, the fundamental analysis deals with the political and economic data news of a country and examines anything that can have an impact on the currency rate. Economic factors, geopolitical impacts, and market sentiments are among the indispensable elements of the fundamental analysis. Professional traders already acknowledge that reliance on merely one of the above analyses is insufficient and they should not be biased against any of them to the exclusion of another. It is competence and aptitude that results in flawless and smart analyses.