You’ve probably heard about fundamental analysis when it comes to stocks, but what about forex fundamental analysis?
This piece will cover some of the basics, and guide you toward more in depth resources along the way.
Much like performing fundamental analysis on a stock, forex fundamental analysis means looking at the forces that determine the price of a currency pair.
This way, an analyst determines where those forces are going next since that’s where price will go.
In essence, forex fundamental analysis breaks down currency movements to the reasons that move price.
For example, if
1. You know the Federal Reserve (FED) is going to increase interest rates (Hawks winning).
2. You know the FED increases interest rates by decreasing the amount of dollars in circulation…
3. From economics 101, you know that less supply for same demand = higher price.
Then, you know (or are very, very convinced) that the USD is going to gain value against other currencies (on average, since it also depends on the fundamentals of the other currency in the pair).
If you also know, for example, that the Bank of Japan is in the middle of decreasing interest rates (the opposite of the FED), then you know that buying USD/JPY might be a good idea.
Obviously, it’s not as simple, since many other fundamental factors can affect price at any given moment.
But once you have the hang of all important fundamentals for the currencies you’re considering, you’ll be a money machine.
But we are getting ahead of ourselves.
I mean, there wouldn’t be as many unprofitable traders if it were as simple no?
Keep reading to discover why this happens (besides the psychological aspect of trading).
If you’re completely new to fx trading, I bet you can see from the previous example, the power behind trading fundamentals.
In my experience, when you trade the fundamentals, you know what you’re doing (or you feel that way, at least).
You feel in control because you know what is going on in the markets.
Contrast that to trading on only technical indicators, or even price action on its own, and you can probably see why I’m a big fan of forex fundamental analysis.
Trading without fundamentals is like crossing a street blindfolded.
On top of this, the consensus among the brightest minds in the world is that fundamental analysis is more powerful than technical analysis when it comes to picking winning assets.
Like I mentioned in an email to my Forex Economist Daily subscribers, developed markets seem to exhibit what is called weak market efficiency.
This means that price takes into account all information which could be obtained from past prices.
In effect, this renders technical analysis somewhat moot.
A more strict form of market efficiency: semi-strong market efficiency, would render even fundamental analysis useless, since according to it, price takes into account all fundamental information available.
However, this second, stronger type of market efficiency is not as strongly supported by practitioners and researchers alike.
Finally, for sake of completeness, the strongest type of efficiency is the strong market efficiency.
According to it, even insider information is already factored into prices.
Now, think about what all of this means.
The strongest type of edge a trader can have is insider information.
The second best type of information is fundamental analysis (think of Warren Buffet in both equities and currencies).
And the worst (if used exclusively) type of information is technical analysis.
Since insider trading is mostly illegal (and how would you do it in currency markets?) we are left with fundamental and technical tools.
So I’m going to ask you a question, if given the choice, which one would you pick, technical-heavy or Forex fundamental analysis?
I’d choose fundamental every single day (of course using some technical tools can enhance your analysis, but these are not the core of your trading strategy).
I hope this point is clear.
A couple of reasons, some of which I already mentioned on forex technical analysis part 2.
1. They prefer to be right than to be profitable.
Once you’ve been trading a certain way, it’s incredibly hard to look at yourself in the mirror and admit that you were wrong (or at least, that you need to learn more).
Most people would rather save face than actually learn how to trade currencies profitably.
Especially if they have argued with other traders about how superior their system is (not based on actual results, of course).
Some of these people are lost causes in the sense that they’re not willing to hear it.
And thus, they’re not willing to learn.
I don’t know about you, but for me, forex trading is not about being right or wrong, it’s about learning continually to make profits in the long term.
To some of these people, being right is what matters…
2. It’s easy
Yep, that’s right.
Why check the news every day when you can just wait for your indicators to tell you when to trade?
You don’t have to think. You just press a button. And if I don’t make money? It’s the system’s fault, right?
Most people are lazy. It’s human nature, and I have nothing against this.
However, the belief that a system will tell you when to press a button, and you will become rich just by pressing it, sounds a little too good to be true, doesn’t it?
And I know, many technical-only traders will jump at me, yelling at the top of their lungs about how much skill is required to execute technical trades, etc., etc.
But the truth remains.
You guys didn’t take the effort to learn forex fundamental analysis.
Which means there is a whole world of information out there that you willingly chose to ignore.
This is laziness at its best, and myopia and ignorance at its worst.
3. It’s easier to create and sell new “flashy” indicators than it is to teach fundamentals.
You can find infinite ways to distort price with mathematical formulas, believe me, I have a Master’s degree in pure mathematics.
What this means is, sellers, many of them, unscrupulous, can keep coming up with new systems that supposedly tell you when money can be made in the markets.
But as modern finance as taught us with the recent financial crisis, more complicated systems are not necessarily better.
And to be honest, if such a system existed, would you sell it to random people? Or would you profit quietly?
Maybe it does work, but income is too little, in which case, a seller wants to make money in other ways.
More likely though, the system does not work (by itself at least) and the trader is left in limbo…
that place where you make some, lose some, and you can’t really tell what’s needed to start being consistent.
Wait. There are successful tech-only traders, what do you say to that?
I’m not saying such methods won’t ever work. But they’re harder, wayyyy harder.
I mean, if your goal is to be an expert price action trader, sure go ahead. Find a system you like and backtest the crap out of it.
Then go ahead and practice to develop your skills on thousands and thousands of trades for the promise of expertise at the end (who knows when, or if it’ll come, or if it’ll make it rain $$).
But if you want to make money trading forex...
The best way to get there (and the fastest way) is to learn your fundamentals down to pat and use some technical analysis to increase a trade’s likelihood of winning.
First thing is first. You must learn about the forces which move currency prices.
If you haven’t already, go check Forex Economics, in this page I describe these forces in more detail.
After you’ve done that, the second step is to stay on top of what’s going on in the markets.
I will make a page on market sentiment, which was not addressed sufficiently in the economics piece.
This is also an important fundamental aspect of trading.
After you have your fundamentals down. And you know what’s going on in the markets you can start trading.
You will know where a currency is expected to go, why that’s the consensus, whether the market sentiment supports that direction, and in many instances, what analysts’ forecasts of price are.
This way, you can see how forex fundamental analysis is very useful if you want to trade forex news.
Once you have all of these things working for a trade, you use a few technical tools such as support and resistance zones or Fibonacci ratios, and if they also support the trade:
Congratulations, you have a winning setup!
After you enter the trade, everything else depends on your psychology and trade, risk management skills.
Hopefully, you’ve found this piece useful.
If you’re just starting out, I cross my fingers you make the right decision and decide to learn both forex fundamental analysis and forex technical analysis (with focus on the first).
In the spirit of furthering your cause, go ahead and browse the rest of the site.
If you’re looking for a Forex Fundamental Analysis program I could recommend (aside from my own) I suggest you check out Jarrat Davis’ program at Jarratdavis.com. As a disclaimer, this is not an affiliate link.
You can also check some of his trading signals at forexpeacearmy.com.
And of course, you can always sign up for my daily email tips list: Forex Economist Daily with your email in the box at the bottom of the page.
See you soon,
The Forex Economist
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