Fundamental Forex Analysis Explained in Plain English

By: Ian Armstrong

If you've been trading for a while, no doubt you know that as a smart trader, you have to be able to analyze the market and predict price movements. This is true whether you trade in commodities, stocks, bonds, currency or any other type of security.

You can do analysis in two different ways. You can utilize fundamental analysis and technical analysis.

Technical analysis studies prices. Here, you want to analyze price movement history so that you can try to predict future prices.

Fundamental analysis studies a nation's overall economic health. This can otherwise be termed as "big picture" analysis. You focus on the strength of a nation's economy and how it will affect the supply and demand of its currency. This, in turn, will affect the currency's price.

As an example, let's say that the US economy is in a major positive trend. The economy is strong, so the dollar is expected to rise, and currency traders will invest great amounts in the dollar. This can be a self-fulfilling prophecy, so that the dollar increases in value.

As a concept, that's pretty simple, but it's not so easy to judge the health of the nation's economy. In fact, you need to consider many things. Two traders may look at the same figures and come up with entirely different interpretations of the data.

Those who focus on fundamental analysis look at a variety of economic indicators to determine how strong a particular economy is. Some of the indicators they may analyze include the unemployment rate, the interest rate, gross domestic product, and the Consumer Price Index.

Various government agencies regularly release reports on these factors, as do non-government agencies. Find the latest schedule of upcoming releases and make note of them. Keep an eye on them for a few months to see what effect if any they have on currency prices.

One thing you should keep in mind is that it's often not the numbers in a report that carry the greatest impact, but the relation of the numbers to what was forecasted.

Put another way, if interest rates rise, this may not have a significant impact if forecasters were indeed expecting it. However, if they weren't expecting it, and they expected interest rates to remain steady or fall, an unexpected increase may have a significant impact on currency prices.

Fundamental analysis does have a disadvantage in that it can be a little too general, a little too "big picture." It's wonderful to predict overall economic growth and price changes that result, but you can't usually get enough detail from it to target specific exit and entry points. This is why technical analysis is just as important, so that it can help to further refine an estimate based on a "big picture" prediction with fundamental analysis.

In conclusion, successful forex traders usually develop a trading system that's based on a mix of fundamental and technical "triggers" to instigate trading orders. Some, however, have been successful with using as few indicating sources as possible to determine trades - such as price-driven variables on a certain currency pair.

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