In forex trading and in the financial markets generally, there are two major forms of analysis and methods through which traders consistently extract profits from the market: Fundamental Analysis and Technical Analysis.
Some traders often combine both to increase their hedge and prediction accuracy.
In this article, we will discuss the importance of fundamentals (fundamental analysis) in forex trading.
Fundamental analysis is an approach to analyzing the markets by looking into the intrinsic value of the investments and researching factors that affect the change in price and future effects on the price of the investment.
In forex trading, fundamental analysis is the study of economic events, development and conditions that affect the worth of a nation's currency.
This study is based on market trends, economic indicators, and outside factors.
The major goal of fundamental analysis is to establish whether a currency is undervalued or overvalued which allows traders and investors to make wise investment decisions.
Fundamental analysis requires research into the major factors that play a role in the movement of a currency.
Here is a list of 6 fundamental factors that play a role in the movement of a currency.
Economic indicators are data reports that are released by government and/or private organizations that provide valuable information on a country's economic performance.
These are reports such as unemployment claims, real estate and housing statistics and so on. Each of these reports is peculiar and serves as an economic indicator for investors and traders.
Typically controlled by the Central Banks, inflation happens when the purchasing power of a currency reduces drastically.
A nation experiencing a low inflation rate is deemed to have strong economic growth, while high inflation in a country means a weak economy.
A low inflation in a country is characterized by reduced prices for consumer products, increased foreign visitors and foreign exchange, increased demand of currency and increased value of currency. The opposite of this is true for high inflation.
The gross domestic product is a very important fundamental factor that measures the economy of a country, in that it gives a calculation of the total value of goods and services produced within an economy in a given year.
If the GDP of a country is expanding, the profits will eventually boil down to consumers, causing an increase in consumer spending.
Since the GDP figure is usually considered by investors and traders as an important "lagging indicator", most of them shift their attention to two reports that are issued in the months before the final GDP figures: the advance report and the preliminary report.
Since the CPI is a tool used to see if a country is making or losing money on its products and services, it calculates the price change in consumer goods.
The CPI news release is often characterized by an immediate unidirectional movement on the charts which could be very dangerous for traders' capitals if proper risk management is not used.
Employment data is the measure of the overall number of employment in a country in a given year. This report impacts the present and future spending since the level of employment influences currency exchange rates.
When there's an increase in the employment rate in a country, it indicates a thriving economy which makes the demand for the currency continue to soar. The opposite is true for the increased unemployment rate.
Retail sales report measures the total receipts of retail stores in a country. This report also helps to indicate consumer spending.
Retail sales can be used to predict the well-doing of more important lagging indicators and determine an economy's immediate direction.
Having known the major fundamentals in trading, let's now discuss their importance.
Fundamentals in trading provides valuable information for traders and investors in order for them to make well-informed decisions. Their knowledge about the economic state of the country and major factors aids their profitability in the market.
By having an in-depth understanding of economic indicators and events traders can with a degree of precision, project market trends.
Fundamental analysis helps traders "see the future" of the markets.
As we all know, the forex market provides endless opportunities for traders to take advantage of. However, traders find it difficult to recognise these opportunities when they present themselves.
Fundamental analysis helps traders identify profitable trading opportunities such as undervalued currencies which have the propensity of soaring high, interpretation of news reports and so on.
Fundamental analysis helps traders strategize on how to project into the far future, positions that could hold true and be repeated over and over again after some confluence.
It helps traders to be patient and unbothered by the little market fluctuations.
Fundamental analysis helps traders to understand the factors behind price movements and price action fully.
It provides traders with the bigger picture of what is actually moving the market.
It deepens the knowledge of traders in understanding the values of currencies, giving them solid reasons to enter into trades.
To conclude, the significance of fundamentals in forex trading cannot be overemphasized.
Fundamental analysis provides traders with a comprehensive understanding of the economic landscape which enables them to make informed decisions and project market trends with precision.
By looking into economic indicators such as GDP, inflation rates, employment data, and retail sales, traders can identify trading opportunities, formulate long-term strategies, and navigate market fluctuations with patience.
Fundamental analysis serves as a guiding light for traders, allowing them to recognize undervalued currencies, interpret news reports, and comprehend the underlying factors influencing market movements.
This approach not only aids profitability but also deepens traders' comprehension of currency values.
Ultimately, fundamental analysis empowers traders to "see the future" of the markets, fostering a strategic and patient approach that goes beyond short-term fluctuations. In the dynamic world of forex trading, a solid grasp of fundamentals is the cornerstone for success, providing a roadmap for sustainable and profitable trading strategies.