Fundamental Analysis in the stock market involves analyzing the inputs of a company in an effort to forecast future growth potential. For an individual company, this can be a very logical way to look for investment ideas. Due to the nature of the market, many traders refer to technical analysis, and we showed you how fundamental data events can be traded with technical analysis in the article The Potent Combination of Fundamentals and Price Action.
Currency prices matter because of cross-border trade. In the article, we saw how the nation of Japan was absolutely ravaged by a strong yen ; as a stronger yen meant lower profits and margins for Japanese exporters. The concept of Fundamental Analysis in the Forex Market can be all boiled down to one simple data point: If interest rates move higher, investors have a greater incentive to invest their capital; and if interest rates move lower, that incentive is lessened.
This relationship is at the heart and soul of macroeconomics; and this is what allows Central Bankers to have tools to steward their respective economies. The decision to increase or decrease rates can bring impact to other economies as well. After having little incentive and extremely low rates for a long time, you notice that The United Kingdom increases rates 25 basis points.
This increase in interest rates from the Bank of England can and should bring higher rates in other issues from The United Kingdom; so you may not necessarily buy Gilts or a government bond, but investors can now look to invest in England to get that higher rate of return. Additional investors thinking the same thing rush into UK bonds, and eventually — the price of the British Pound will go up to reflect this additional demand.
A great example of this was in Australia from leading up to the Financial Collapse; as insatiable demand from China drove growth throughout Australia, unemployment got very low and inflation moved very high.
The Aussie more than doubled while RBA moved rates from 4. This is an interest rate cycle, and it drives capital flows that are at the heart of the FX market. It all goes back to the incentive to invest. If Central Bankers want to slow down their economy, they look to raise rates. If they want to encourage more growth within an economy, they look to decrease rates.
The first and most obvious impact is the incentive to invest. The second impact is what this does for capital expenditures. If rates decrease, the attractiveness of locking up a long-term loan at the new lower rate is much higher than it was previously. The incentive to buy big-ticket items like homes, and cars is now higher. And when you buy a home or a car, the homebuilder or car maker has to turn around to pay for their materials and workers. If the lower rates increase the number of homes or cars that are being purchased, this amounts to growth.
Homebuilders and car makers will eventually have to hire new workers to keep up with the demand; and as demand for workers increases, so will the wages that are needed to attract qualified candidates. Prices can continue inflating, and if left unchecked — could bring hyperinflation. Imagine going to the store to buy a gallon of milk and seeing the price at 27 dollars. Then my mind would wander to other areas where costs might be increasing.
If a gallon of milk is 27 dollars, then how much will that new car cost me? How much is milk going to cost tomorrow? So, Central Banks want a moderate rate of inflation. Both Central Bankers and Forex Traders watch macroeconomic data prints with the goal of getting something out of them; but their objectives are slightly different.
FX Traders are often interested in the price reaction of a data print. If CPI comes out higher than expected, then traders may be looking for long positions to move higher. FX Traders can price in new data quickly, creating volatile price movements. Central Bankers want to watch the primary points of reference for an economy in an effort to make the correct decision as to where to move rates.
Inflation and employment are chief amongst these statistics, as these are two of the primary pressure points within an economy. If unemployment is high, the economy will likely struggle. FX Traders will begin pricing this in with the probability of an eventual rate hike or cut by Central Bankers to factor this information in. As inflation CPI data prints are released in an economy, traders will act quickly to incorporate this new information in to prices. Meanwhile, Central Bankers are watching cautiously to decide if they want to do anything at their next meeting.
Increasing unemployment decreasing employment along with decreasing inflation are threats to an economy that will usually see Central Bankers investigate rate cuts. Decreasing unemployment increasing employment , and increasing inflation are signs of a growing economy, and this is when Central bankers will look at potential rate hikes.
But, Central Bankers and Forex traders alike are not happy to just sit around and wait for employment or inflation numbers to show changes within an economy. This has brought to light numerous additional data prints that traders and investors will look to in an effort to anticipate changes to inflation, unemployment and interest rates. Consumer statistics are extremely important in large economies like The United States, or Europe in which consumer activity has a heightened level of importance for the global economy.
In the article, The Lifeblood of the US Economy , we looked at the major data releases that include this information. The Euro can get extremely volatile around releases of Consumer Sentiment Numbers, and this is because consumer activity in established economies is often looked at as a precursor to inflation, employment, and growth.
GDP, or Gross Domestic Product, is a direct expression of growth or contraction within an economy, and this can also be a huge precursor to price movements; especially if the announced rate of growth is far away from expectations.
Production numbers can be especially important in growing economies that are at a very industrialized stage of the growth process. The thought behind this statistic is that if producers are seeing growth, then that growth will eventually cycle through to consumers; after all, if someone wants to buy a good, it has to be produced in the first place, right?
This makes trading on fundamentals in the FX market dangerous; because you could guess that GDP is going to come out better than expected, and you can trade it accordingly and still eat a stop. You can be right, and still lose. In stocks, trading on fundamentals makes a lot of sense. You can grade company A versus company B in relevant markets.
For this reason, many traders in the FX market incorporate or include Technical Analysis in their fundamental trade ideas. This can bring quite a bit of benefit to the trader in helping to determine trends or biases that may have been exhibited in a currency. Earlier in the article, we used the hypothetical example of the Bank of England increasing interest rates 25 basis points.
This increased demand will show higher prices. So, this is a fundamental theme — that is clear and apparent in the technical setup of the chart. If there is an up-trend, prices are moving higher for a reason, right? Traders can incorporate price action to see where these trends may be existing, and to what degree they might be traded. Then, traders can also use price action to buy up-trends cheaply, and sell down-trends expensively; so that if that momentum continues, they can look to profit.
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets. Click here to dismiss. Price action and Macro. Fundamental Analysis in the Currency markets centers around Macroeconomic data Macroeconomic analysis can be simplified by focusing on interest rates and expectations Traders can incorporate Price Action to make analysis even more simplistic Fundamental Analysis in the stock market involves analyzing the inputs of a company in an effort to forecast future growth potential.
Why Currency Values Matter Currency prices matter because of cross-border trade. Higher or lower rates bring a two-pronged impact on the economy. What do Central Bankers Watch? How Technical Analysis can improve your fundamental approach Earlier in the article, we used the hypothetical example of the Bank of England increasing interest rates 25 basis points. Prices can show biases and trends in fundamental data Taken from The Potent Combination of Fundamentals and Price Action Traders can incorporate price action to see where these trends may be existing, and to what degree they might be traded.
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