Forex fundamental analysis is about identifying and measuring the factors that affect the fundamental worth of financial instruments. These can be economic or political climate of a country as well as the fundamental issues that will influence the supply and demand of a product or services. For example, a decrease in the supply of a product without any change in the demand of a product will result in an increase in the market price. In contrast, any increase on the supply side will have the opposite result that is a decrease in the market price.
In the context of Forex trading, a fundamentalist will study the supply and demand of a country’s currency, its merchandise trade (products & services), its government policies, the way the country is managed. He will also analyze the past and forecasted performances of the country’s economy and the future plans of the country, both economic and political. For the short term, all economic indicators need to be looked at.
Using the data obtained, the fundamentalist will then construct financial models to help predict both the current and forecasted value of a specific currency against its corresponding pair. The underlying idea is that any unparalleled increase in the supply will lower the value of the currency. On the contrary, any unparalleled increase in the demand will push the value of the currency up. Once the fundamentalist is able to discern this estimate from the financial models constructed, he will be able to predict if the currency rate is likely to fall or increase.
Some of the data that fundamentalist trader relies on comes from the economic calendar. Other factors that a fundamentalist will rely on are speeches of the US Federal Reserve chairman, Secretary of the Treasury and those who are prominent in the financial sectors. In addition to speeches, fundamental analysis also relies on interest rates. Normally, interest rates increase will cause the currency value to increase as well as more investors start to park their assets in that country’s currency. Other important economic data that will be studied will include the unemployment rates, the Gross Domestic Product growth rate, figures of retail sales and consumer price index. A high GDP growth rate will indicate a robust economy which in turn implies higher interest rates. Higher consumer price index will mean higher rates of inflation. This will naturally result in interest rates rising meaning that the value of the country’s currency will go up.
The trade balance figures and country budget are also important data that need to be studied. Countries with a high trade deficit will normally indicate a weak currency. One of the main drawbacks of fundamental analysis is that it is difficult to accurately assess interaction between the variables. Thus, a lot of the forecasted estimates are based on the fundamentalist’s experiences. Furthermore, the Forex market has the tendency to be self fulfilling making the analysis obsolete at times. Lastly, depending on the timing, the market usually takes some time to adjust itself to the changing economic factors.