The two primary approaches used by traders worldwide to analyze currency markets are fundamental analysis and technical analysis. Fundamentals focus on financial and economic theories, as well as political developments, to determine forces of supply and demand.
Fundamental analysis comprises the examination of macro-economic indicators, asset markets and political considerations when evaluating one nation’s currency relative to another. Macro-economic indicators include figures such as growth rates, as measured by Gross Domestic Product, interest rates, inflation, unemployment, money supply, Foreign Exchange reserves and productivity. Asset markets comprise stocks, bonds and property. Political considerations affect the level of confidence in a nation’s government, the climate of stability and level of certainty.
Trading on the fundamentals – also referred to as trading the news – is the study of news events and economic statistics to determine trading opportunities. These traders pay close attention to changes in economic indicators such as interest rates, employment rates, inflation and many more as forex market prices are impacted by macro and micro-economic data, geo-political events and their linkages.
Begins by analyzing broad brush macroeconomic factors and aggregates of data working downwards narrowing and refining the search to include only those currency pairs that present a profit potential.
These factors are key drivers for currencies. If a country has a trade surplus this implies there is a high demand for its goods and services, consequently a greater demand for its currency thus driving up relative value. Similarly, higher relative interest rates lead to cash inflows, thus driving up the value of a currency.
Conversely, this type of analysis starts with analyzing the currency pair working upwards to aggregate macroeconomic information.
These have a significant impact on the valuation of commodities. For example, a growth of international conflict may result in increased demand for nickel, which is used in armaments and ammunition manufacturing driving up prices.