Fundamental Analysis
The basic premise of fundamental analysis is that the value of a
currency is determined by the comparative strength and weakness
of a country’s economy in relation to those of its trading
partners. The stronger a country’s economy – measured in higher
GDP growth, lower inflation, higher interest rates, greater
productivity, more political stability, etc. – the stronger a
country’s currency. Over time, these fundamental factors produce
the long lasting price trends typical of the currency markets.
Many factors pertaining to a national economy are monitored,
assessed and judged for the effect they have on economic growth
and development. These trends are often large and complicated,
and can be enacted over a long period of time. Another factor
which affects a country’s economic status is its political
system – the balance between social welfare and individual
competition, or the openness of an economy to foreign trade and
capital. Other areas include the social and cultural makeup of a
nation, such as the productivity, labor mobility, and
entrepreneurship. Natural resources also play a part, such as
oil or mineral deposits.
Fundamental analysis views an economy and its currency through
economic statistics. These statistics often depict a particular
sector of an economy rather than the economy as a whole. Because
of this, different statistics may point in opposite directions;
one area of an economy may be growing while another falters, or
the importance of one industry declines as another rises. Most
statistics are also retrograde, telling you what has already
happened, but not necessarily what is to come.
In our interconnected and volatile world, political, military,
human, and even natural events can have rapid, vast, and
long-lasting repercussions. A fundamental analyst must take into
consideration all this information to create an overall picture
of an economy – its strengths, weaknesses, vulnerabilities and,
most importantly, its future potential and the likely future
course of its currency. Personal judgment and experience come
into play to complete the fundamental currency analysis.
Market Drivers
A Forex market transaction differs from a retail transaction. In
a retail environment, the price is predetermined by the seller,
and the purchaser measures his need for the item against the
price asked and makes his decision to buy or not. In a market
transaction, both the seller and the buyer continually adjust
their price expectations to the information flowing out from the
market to its participants and into the market from outside
sources.
A seller who thinks that the price may be higher in a few
minutes may choose to withdraw an offer hoping to get a higher
rate. If enough sellers withdraw their offers at a specific
level the deal price will rise to the next available offer. But
if traders think the price may fall then they may lower their
own offers until they find a buyer, in effect driving the market
price lower.
When each participant in the market reacts to this changing
information, the combined reaction results in the movement in
price. It appears to an observer that the ‘market’ traded lower
only because the thousands of individual decisions that comprise
the movement are not given separate life – only the mass
decision, ‘the price’, is represented. We often say ‘the market
reacted badly to the news’ or ‘the market took profit today’.
But the common use of this ‘market’ shorthand tends to obscure
what is most important psychological point in understanding
market behaviour – the ‘market’ is a picture of the thoughts of
its participants, a snapshot of our minds.
The difference between what the market participants assume will
happen in the market and what reality proves produces market
movement. When a particular economic statistic is released, and
it’s at or close to the general opinion of what the result would
be, then the trading reaction is muted. The statistic is said to
be ‘priced into the market’, which means that many prior trading
decisions assumed the state of the economy portrayed by the
statistic and that has become reflected in the trading rate.
If the statistic proves to be different than this assumption,
then most of those trading decisions will be immediately
unwound, and result is price movements that reflect those
changes. It is this tension between the opinion of the majority
of market participants as reflected in the trading rate, and the
economic, statistical or rate reality that dominates currency
trading.
