Fundamental Forex Analysis

Learn> Fundamental Analysis

Fundamental analysis

Fundamental analysis, just like technical analysis, is about evaluating the upside or downside potential of an underlying. It is a deterministic approach based on hypothetico-deductive reasoning, which is basically the opposite of technical analysis. In this type of reasoning, it is necessary to deduce conclusions from pure hypotheses and not only from real observations. This directly implies a good mastery of economic concepts as well as important stages of reflection.
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As you must know, fundamental analysis is done more often by professionals than by individuals. The reason is no longer long and complicated to learn, private stakeholders generally prefer to turn to technical analysis which is much simpler to practice.

The two families of fundamental analysis:




Trade the economic news

We can trade news, it is a fairly common method among individuals as well as professionals. In the absolute, it's not complicated, just know the impact that will have some statistics on Forex prices. At the moment the figure appears, we open a position in the right direction and we keep a few minutes hoping for a sudden acceleration following the release. This method presents no particular reasoning, only some economic knowledge is enough to trade, for example US unemployment figures will fall, if they are positive we will rather buy the dollar and vice versa if they are negative. In short it is really not difficult, it is just enough to choose some recurrent statistics (unemployment, CPI, policy rates, ..) and to trade the pairs corresponding to their appearances.

Obviously it is not a miracle method either, on the one hand you have to be patient, then the figures have to have a sufficient impact on the prices to reach your takeprofit. In addition, in phases where volatility is too high, order execution is not optimal and slippage is often required. However, by remaining rigorous and serious in its method, this approach is often quite rewarding. The main disadvantage is to be necessarily present at the time of publication, usually the biggest announcements are made in the early afternoon and therefore it is difficult for people who are at work or in class (for students ).

Basically, "trader news" is related to fundamental analysis only through in-depth knowledge of the economic indicators that are being monitored. We will now see what really lies in fundamental analysis.

Trader on the economic climate

To trade by practicing the fundamental analysis is to accept to trade on important scales of time. Indeed, when we trade fundamental analysis on feelings of the economic climate, they are positions generally of several weeks / month. It would be difficult in one course to give you all the keys necessary to understand the economic theories nevertheless, we will study some economic quantities to judge the effectiveness of a currency area.

Examples of Forex Economic News

Interest rates
Once again we will not go looking for details. Key interest rates are primarily tools for central banks to manage inflation in monetary areas (but not deflation). Indeed, too much inflation can be offset by high interest rates.

Why is that ?





This is not complicated, a rise in the key rate will be passed on in financial institutions by a rise in the rate of credit and savings. The rise in the savings rate will encourage households to open savings accounts or take out financial investments. They therefore give up their immediate consumption for a greater future consumption. The direct consequence is the immediate slowing down of consumption and therefore of demand, and a drop in demand in the face of a stable supply implies a fall in prices and therefore a disinflation.

We will now see the link between the interest rate and the exchange rate. Here the approach is completely different from the one used previously. Let's take an example to understand the logic: If the ECB chooses to increase its key rate, then the interest rate differentials of the Euro against other currencies will be more favorable, therefore investors will be encouraged to buy from the euro. euro / (other) in the case of a positive differential. This action directly produces an increase in demand for euros and therefore an appreciation of this currency.

The trade balance:

The trade balance is the difference between a country's exports and imports, so if a country exports more than it imports, it will have a positive trade balance, it will be considered surplus, and if it imports more than it exports then it will have a deficit balance.

Transaction invoices between countries are in the currency of the exporting country, therefore the importer will have to buy the foreign currency and simultaneously sell his own currency. We understand immediately the reaction of the exchange rate.

Let's take an example: Consider that a French company exports to another company located in the USA, then the importing company (USA) will have to buy Euros and simultaneously sell Dollars to pay the bill. In this case, there will be a rise in demand in Euros and an increase in the offer in Dollars therefore an appreciation of the Euro and a depreciation of the Dollar and therefore a EUR / USD exchange rate rising.

Inflation:

Inflation, as we said earlier, is the relative increase in prices from one year to the next. The benchmark for calculating inflation is the CPI (Consumer Price Index). To calculate inflation, it is sufficient to observe the relative change in the CPI from the previous year to the current year.

Without entering into complex explanations, theorists consider that it is possible to predict the evolution of exchange rates by comparing a basket of goods and services from one country to another. The idea of ​​this theory is based on the fact that exchange rates are fixed relative to the relative prices of goods between two countries. What must be remembered is that the evolution of consumer prices is offset by a reverse evolution of exchange rates, for example if inflation increases in France then the Euro will tend to depreciate. This relationship is especially true over the long term rather than the short term.

Conclusion on the fundamental analysis:

We have finished this introductory course in fundamental analysis, we have introduced some relations between economic quantities and exchange rates. It is important to remember that fundamental analysis is not opposed to technical analysis, it is largely possible to combine the two types of forex analysis to best achieve its forecasts.