Fundamental analysis of Forex is a method of assessing the market situation, which proceeds from the fact that the influence on the foreign exchange market is the fundamental factors of the economy. The task of fundamental analysis is precisely the study of such factors and the identification of patterns.
The subject of fundamental analysis
The subject of fundamental analysis is the reasons that affect the dynamics of prices in the foreign exchange market. This is a rather complex and time-consuming assessment process. Just as stockbrokers measure the health of a publicly traded company by examining its balance sheet, debt and cash flow statistics, a Forex trader chooses the reasonableness of a national economy by considering things like Central Bank interest rate differentials (which is the difference between borrowing costs, as decided by central banks of different countries), active trade balance or deficits, along with employment trends, productivity and many other factors.
Fundamental analysis reveals the causes of the main price dynamics in a direct and clear way. For example, due to the ease of borrowing and the resulting abundance of global liquidity in recent years, the interest rate differential between the central banks of the two countries has been the most important indicator in determining price trends in the foreign exchange market. It is unlikely that interest rates will remain one of the most important factors in changing the foreign exchange market as much as financial players who can freely move capital across national borders.
Fundamental analysis tries to detect and predict the causes of Forex trends, and at the same time it uses many indicators to present a comprehensive picture of global finance. But outside of the indicators themselves, what really makes the currency exchange rate move in a special direction? Are currency fluctuations really solved only by statistics and the flow of news?
Fundamental analysis tries to predict cash flows in the form and on the basis of a special currency. The statistics are significant only to the extent that the markets regard them as a basis for directing international cash flows. A country can have very low unemployment, excellent productivity indicators and very good statistics in general, and its currency can still have a strong impact-if, despite all those advantages, the aggregate supply exceeds the demand of the currency. In other words, no indicator, no statistical value or standard is sufficient to fully assess the superiority of one currency over another, if the general economic situation (i.e., financial markets as a whole) does not want to take advantage of the advantages provided by a thriving economy.
Indicators of fundamental analysis
The indicators of fundamental analysis include:
- Indicators of the movement of trade and investment capital (trade balance; current account balance; capital account balance; balance of payments)
- Indicators characterizing the state of the country's financial market ( the amount of US Treasury bonds placed and the rate and dynamics of the volume and placement rate; the dynamics of stock indices;the dynamics of interest rates on the interbank credit market; the dynamics of yields on medium-and long-term government securities)
- Aggregated macroeconomic indicators (GDP, volume and dynamics of public expenditures, volume and dynamics of revenues to the country's budget, budget deficit / surplus, etc.)
- Indicators of the dynamics of production and trade
- Labor statistics indicators
- Inflation indicators
- Indicators of monetary regulation of the economy
The relationship between strategy and fundamental analysis
The strength of fundamental analysis lies in its connections with economic events in general. And, the fact that the fundamental reasons decide the main trends in the currency markets is indisputable. The trader has a very reliable tool in this type of analysis. The problem with fundamental analysis, on the other hand, is twofold: there is no clear link to the time factor; and markets do not always react to factors in a rational way. The thing to remember when the market value of a currency differs significantly from its basic value is that the market would not allow a non-rational price assignment if certain people did not receive a large profit from it. Therefore, it is necessary for the analyst to identify this discrepancy, investigate the reasons for it and formulate a strategy to use it.
The difference between fundamental and technical analysis
Technical analysis differs from fundamental analysis, which is based on the analysis of currency pairs. Technical analysis analyzes price, volume, and other market information, while fundamental analysis focuses on the facts of the company, market, currency, or commodity. Most large brokerage, trading groups, or financial institutions, as a rule, contain divisions that conduct both technical analysis and fundamental analysis.
Technical analysis is widely used by traders and financial specialists, and is also very often used by active intraday traders, market makers and commodity exchange brokers. Users believe that even if technical analysis cannot predict the future, it helps to determine trading opportunities.
In the foreign exchange markets, its use may be broader than fundamental analysis. This does not mean that technical analysis is more applicable to foreign markets, but that technical analysis is more recognizable in order to apply it effectively here than anywhere else. While some individual studies have shown that technical trading rules can lead to consistent returns in the period before 1987, most of the theoretical work has focused on the nature of the abnormal position of the foreign exchange market. It was assumed that this anomaly was due to the intervention of the central bank, which, obviously, technical analysis could not predict. Recent studies show that by combining various trading signals into a single approach, it is possible to increase profitability and reduce dependence on any one rule.