Using fundamental analysis

Author: Forex Live | Category: Education

Understanding better the need for fundamental analysis

FX
Before making and applying a fundamental analysis, traders must list all the currencies their forex broker offers for trading. Then, search for recent data on the currencies that might influence their behavior in an economic calendar.

The Gross Domestic Product (GDP) and interest rate are some of the commonly employed data to perform fundamental analysis.

Also, it is important to consider the actual figures, and the market consensus forecasts - which are available on any regular economic calendar. They can use the said data to analyze and compare the trends and ensure if the actual figures align with the expert's forecasts.

The last step is essential since the economic data publication's impact depends if the markets did not expect the information. But if the figure stays in line with the market consensus, then the effect of its publication will be relatively lower as the information might have already priced in the markets.

For instance, when the U.S. Bureau of Economic Analysis reports that the United States GDP boosted in the last quarter, this would definitely be a bullish sign as it hints strong fundamentals.

But if the figure stayed in line with the analysts' forecasts, it's possible that the data was already priced in the markets.

Thus, at the time of its publication, the positive effect of this information on the dollar performance might be lower compared if the data came in much higher than expected.

Historical Data

Remember that some analysis might be more effective if they use historical data - which is also available on the regular economic calendar. Here, they can utilize the historical data to identify if the U.S. economic performance is on an upwards trajectory - a sign of a strongly growing economy.

Keep in mind that it is always better to complement analysis using other relevant economic information like the inflation level or the manufacturing PMI. For example, an increasing manufacturing PMI would back up the case for a strongly growing U.S. economy, aiding the bullish position. Contrarily, a negative figure can weaken the assessment, which might be a sign to reconsider the strategy.

Classifying Currencies

With the use of this approach, traders can classify all currencies into three main categories:

  • Currencies with strong fundamentals - this proposes traders to be bullish on the currency.
  • Currencies with weak fundamentals - - this proposes traders to be bearish on the currency.
  • Currencies that are a mixture - this proposes traders to either avoid (temporarily) or be neutral about trading the currency.

When a specific currency contains strong fundamentals, and one of its competitors do not, the typical approach is selling the currency that has weak fundamentals against bullish fundamentals. For instance, if a trader's analysis suggested being bullish on the Japanese Yen and bearish on the Australian Dollar, the trader must sell AUD/JPY. If not, the best strategy is selling the pair.

Be Cautious

Fundamental trading is a powerful method to gain money in the markets, especially if partnered with technical analysis strategies.

But still, traders need to know that the markets might not react the way they expect following the release of economic data, even if its indication looks unambiguously positive or negative. There are times the markets already priced the event or decide to interpret the data in another way.

For instance, an overly positive unemployment level interpreted as a sign of a possible stagnation of the job market or other relevant data that is not positive - like lower average earnings - might be released at the same time and lure the market's attention.

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