Forex fundamental analysis adheres to the basic laws of economics. This includes macroeconomics, microeconomics, monopoly, unemployment, interest rates, supply and demand. The English Economist Adam Smith described how the invisible hand created a self-regulating marketplace.
Supply & Demand
In a perfect world, each nation would have its own currency. This currency would be used as a unit of foreign exchange currency (Forex), it would account for trade balances and national productivity.
Supply and demand are important rules of fundamental analysis. This rule suggests that a Foreign exchange price will be a balancing point between how much currency is supplied and how much currency is demanded. The demand for currency is the desire to possess that currency to purchase a good or service from another nation.
For example, if the Australian mining industry finds a new gold deposit and turns this precious metal into gold coins at the Australian mint, the supply of gold coins has increased. International coin collectors may want to purchase these valuable coins, but need Australian dollars (AUD) to complete the transaction. Thus, the value of the AUD should increase due to higher demand.
A Universal Law
Fundamental analysis helps Forex traders remain focused on the laws of economics. While a price change may appear to be “unpredictable” in the short-term, it should return to a “predictable” price based on fundamental analysis. Adhering to fundamentals, enables Forex traders to earn consistent profits.
Furthermore, nations do not trade for the sake of being kind or benevolent. They trade products and services to gain a comparative advantage. When Forex traders realise that one nation can gain an advantage by undertaking a certain action, then it might be time to execute a trade. National debt is a primary example.
When a nation has a higher risk of defaulting on its national sovereign debt, then its sovereign bonds should offer a higher interest rate. Forex traders can profit when a nation’s chances of defaulting increase or decrease.
Fundamentals establish that marketplaces have a natural tendency to reach an equilibrium based on the invisible hand. Unsustainable national economic policies should lead to a reduction in the value of its currency. Everything works itself out in the long run.
Monopoly Versus Competition
The microeconomics concept of “perfect competition” is also operative for Forex trading. Many economic precepts are formed based on the concepts of “perfect competition” and “perfect information.” If everyone has the same information at the same time and has the option to choose different currencies, then a certain result should occur. The opposite of perfect competition is monopoly.
With perfect competition in supplying something, the price structure tends to be elastic. A good example is wheat – there are many nations producing this grain; thus, a shortage in one country does not dramatically affect the overall price. A scarce commodity – like oil – has an inelastic price curve.
OPEC has created a consortium to control energy prices. A fundamental Forex strategy could concentrate on how supply bottle necks could impact an OPEC member’s currency.
Some advanced traders might use overlapping Forex trades for nations that have close relationships. The AUD, CAD, GBP and USD might see similar Forex moves due to numerous cultural and economic similarities.
Forex Fundamental Analysis Strategies
While technical analysis involves the “tale of the tape” in gauging short-term price movements, the fundamental analysis seeks to find a “reason” for a price change. This could include unemployment figures, productivity reports or interest rate hikes. Each of these fundamentals will impact the value of a currency used for international trade. Here are other common Forex fundamental analysis strategies:
The Indian Hindu calendar has many different festivals, which could impact your trading of the Indian Rupee (INR). The West basically shuts down around Christmas. Holiday seasons could lead to more international Forex trade as gifts are imported from abroad.
Arbitrage is a guaranteed profit due to the same asset being priced differently in different markets. This is a very popular fundamental analysis strategy made more effective due to fast computer automated trade execution. The software programs can find the arbitrage opportunities for you.
Interest rate changes will effect the price for goods and services of a particular nation. Most nations try to devalue their currencies to increase exports.
Australia is primarily a raw materials exporter with much of its national income based on commodities. Thus, dramatic commodity price changes will impact the AUD more drastically.
Frequently Asked Questions (FAQ)
Generally, Forex fundamental analysis strategies are looking at the long-term causes and effects that determine prices. This can be combined with technical analysis to create a comprehensive, diversified plan. Here are a few of the frequently asked questions concerning fundamental analysis:
Isn’t Fundamental Analysis Old School?
Some of the fundamentals, like supply and demand, never change. In the long run, Forex must adhere to the fundamentals, just as water must adhere to the law of gravity.
What if I want quick returns?
You can still earn fast returns trading Forex while following the fundamentals. The fundamentals simply explain why a price changed.
How Can I Use Signals for Fundamental Analysis?
Trading signals can be programmed to execute trades when certain fundamentals occur (i.e. gold price equals a certain amount).
Does Fundamental Analysis Include Risk Management?
Fundamental analysis is a form of risk management, where you never forget the laws of economics.
Forex traders should understand all of the basic rules of economics in order to create the best strategies to earn ample profits. Traders can use technical, charts and high-frequency trading (HFT) to make more money. All successful traders and Australian forex brokers remember that in the end, the fundamentals always win!