Understanding the Basics of Fundamental Analysis in Forex
Forex traders in Kenya, and elsewhere in the world, approach the forex market from two broad perspectives: either through technical analysis or through fundamental analysis. As a beginner, you may spend a lot of time trying to figure out which is the best approach to trading. The truth of the matter is that none is better than the other.
History is full of traders who have made bank by employing any of the above approaches.
In his book, Market Wizards, Jack Schwarger interviews two prominent traders, Ed Seykota and Jim Rogers. Rogers is a diehard fundamental trader who believes that no one can make a living trading forex using technical analysis. He goes ahead to say that he has, in fact, never met a rich technical trader.
Seykota shares the opposite view. According to Seykota, he had always been a poor trader when he relied in fundamental analysis. He insists that his fortune changed when he switched to technical trading.
As stated earlier, none is better than the other. You only need an approach that suits you, stick to it and make bank.
In this article, I am going to disect the basics of fundamental trading, just in case you decide that you decide you want to be a fundamental trader.
What is Fundamental Analysis?
Fundamental analysis is a way of studying a security in order to deternine its intrinsic value by analyzing a host of financial data.
In the forex exchange market, a security would be a currency. Fundamental analysts are always analyzing emerging financial data from a country in order to determine the value of the country’s currency.
There are several important economic indicators that every fundamental forex trader should understand. Fluctuations and variatons in these data will make the currecy value of a country to fall or rise.
Interest rates are the most important driving force of the value of a country’s currency. Most central banks announce the interests rates every single month. Fundamental traders keenly watch these announcements to decide how a currency will be affected.
In general, Central Banks will manipulate the interest rates in order to control the amount of money in circulation. If the Central Bank wants to increase the amount of money in circulation, it lowers the interests, and conversely increases the interest rates when it wants to decrease the supply of its currency in the economy.
Gross Domestic Product (GDP)
GDP is the indicator of how fast a country’s economy is growing. Every country’s Central Bank has expectations of how much the economy is expected to grow every year. When the Gross Domestic Product falls below this expectation, currency values tend to sink while a growth that hits the expected growth rates or goes above raises the value of the currency.
Inflation destroys the purchasing power of a country’s currency, and therefore tends to devalue the currency. It is generally expected that a currency will suffer inflation of 2-3% annually. However, if the inflation rises beyond the Central Bank’s expectations, the Central Bank will increase the interest rates on the currency.
Without people, we wouldn’t have any economic growth. Employment and unemployment are the backbone of every country’s economic growth. When the level of unemployment in a country rises, it tends to have a devastating effects on the economy. To minimize the effects of unemployment on the economy, the Central Banks will reduce the interest rates in an attempt to increase the supply of money in the economy and stimulate economic growth.
As we have already stated, people are the ones that drive economic growth. Healthy consumer demand lies at the center of economic growth. When consumers are able to demand goods and services, the economy tends to grow. When the consumers’ demanding power is decreased, the economy tends to stagnate.