Most traders tend to get their heads deep into the technical analysis of things. From monitoring chart patterns to support/resistance levels and moving averages, clearly, for the trader technical analysis rules. For someone holding their positions for a few hours to a few days, the above approach of relying solely on technicals can be rewarding. However, for the rest of the lot and for the intra-daytrader paying attention to some fundamental data can help in making better calls before taking on a trade.
In this series of articles, we explore a few basic fundamentals that move the forex markets, which is something an investor and even a trader must pay attention to.
Balance of Trade or Trade Flows
The balance of trade is one of the most basic fundamental data to pay attention too. While on its own it might not hold much strength in moving the markets, the balance of trade report which is published every month helps the trader to get a general underlying idea of how the currencies they are trading are most likely to perform.
Trade flows is nothing but the demand of foreign and domestic goods. In other words, domestic demand of foreign goods and foreign demand of domestic goods.
When there is an increase in foreign demand for domestic goods, it requires the buyer to pay in the domestic currency, thus in increase the demand for the domestic currency, while increasing the supply of the foreign currency and vice versa.
For example, if you live in Europe and want to buy that brand new iPad, despite paying for it in Euro’s the distributor would eventually pay Apple in US Dollars. This basically means that Euro’s are sold to buy US Dollars. From a fundamental perspective, this increases the demand for the US Dollar.
When looking at the balance of trade, there are two key terms to bear in mind:
- Trade Surplus – Infers that there was a greater foreign demand of domestic goods/services. This results in an increase in domestic currency, while weakening the strength of the foreign currency.
- Trade Deficit – Infers that there was a greater domestic demand for foreign goods and results in a decline of the domestic currency, while indirectly increase the purchasing power of the foreign currency.
A good real time example for the above can be seen from the Indian economy which in recent times has seen the Indian Rupee depreciate against the Greenback. One of the many reasons attributed to this was due to the drop in Gold prices, enticing consumers in India to buy Gold, which further led to a decrease in the strength of the Indian Rupee. The government, in an effort to stave off further depreciation, announced new measures making it easy for FDI (Foreign Direct Investment) into the country. In other words, entice foreign investors to buy or invest in domestic assets to spruce up the demand for the Indian Rupee.
Other Factors that influence Balance of Trade
As can be seen from the above example, besides just demand of foreign and domestic goods, investments also play a key role when it comes to trade balance. Another aspect that influences the balance of trade is the repatriation of assets.
Repatriation of assets is basically repatriating part or all of the profits made overseas. For example, if Apple reported a healthy quarterly profits, chances are that some of those profits would be repatriated back to the US. In doing so (besides the tax benefits), indirectly this increases the demand of the domestic currency (or the USD in our example).
Trade Balance – Conclusion
Although trade balance is an important fundamental data to keep an eye on, trading solely off this data would not provide good results. As we will cover in future articles, when it comes to fundamentals in forex they do play an important role but should not be viewed independently. For example, when trading off technical analysis and ahead of the trade balance reports, traders should always keep an eye on the data as it could influence the future price direction.