Hint Newletter #4 June 25, 2023
Utilizing Fundamental Analysis
Traders who usually focus on technical analysis in Forex trading believe that market prices already reflect all available information, including fundamental factors. They argue that fundamental analysis, which involves examining economic data and other factors, is already incorporated into the price. However, in this blog, we will cover why having a fundamental outlook on financial markets is equally crucial to analyze the markets.
Fundamental analysis in Forex trading involves analyzing economic, financial, and geopolitical factors to assess the value of currencies and make trading decisions based on those assessments. It aims to understand the forces that drive supply and demand for currencies and how they may impact exchange rates. Let us first go over key macroeconomic indicators to understand what they are and how they could impact the markets:
Interest rate
Central banks, through monetary policy, often use changes in interest rates as a tool to manage their economies. If a central bank raises interest rates, it can make the currency more attractive to foreign investors and potentially strengthen the exchange rate. Conversely, lowering interest rates can make the currency less attractive and potentially weaken the exchange rate.
Central banks are responsible for formulating and implementing monetary policy to achieve certain macroeconomic objectives. One of the major reasons is to combat inflation. Let us demonstrate it through the graphical representation below for easier understanding:
Here are the names of some major central banks in the world:
- Federal Reserve System (FED) – United States
- European Central Bank (ECB) – Eurozone countries
- Bank of Japan (BOJ) – Japan
- Bank of England (BOE) – United Kingdom
- Bank of Canada (BOC) – Canada
- Reserve Bank of New Zealand (RBNZ) – New Zealand
- Swiss National Bank (SNB) – Switzerland
- Reserve Bank of Australia (RBA) – Australia
Inflation rate
Inflation can have a significant impact on forex markets, influencing currency values and exchange rates. When a country experiences higher inflation than its trading partners, its currency depreciates. This is because higher inflation erodes the purchasing power of a currency, reducing its value relative to other currencies. Forex traders may anticipate this depreciation and sell the currency, leading to a decline in its exchange rate.
Consumer Price Index (CPI) is a widely used measure of inflation and price changes in an economy. The CPI tracks the average price level of a basket of goods and services typically consumed by households. It provides insight into the purchasing power of consumers and the overall inflationary pressures in an economy.
CPI data is typically released regularly by government statistical agencies and is an essential economic indicator for policymakers, businesses, and investors. It is specific to each country and is typically released on a monthly or quarterly basis. As inflation rises, the currency’s purchasing power erodes and the prices of goods and services increase.
Gross Domestic Product (GDP)
Gross Domestic Product (GDP) figures can have a notable impact on forex markets as they provide insights into the overall health and performance of an economy.
GDP figures indicate the rate of economic growth or contraction in a country. Strong GDP growth suggests a healthy and expanding economy, which can attract foreign investors and increase demand for the currency.
GDP figures can influence expectations about future monetary policy decisions by central banks. A strong GDP growth figure may lead to expectations of tighter monetary policy, such as interest rate hikes, to prevent overheating or inflation.
Employment
Employment data, particularly indicators such as the unemployment rate and non-farm payrolls, can have a significant impact on forex markets.
Employment data is closely linked to overall economic growth. Positive employment figures, such as a decrease in the unemployment rate or an increase in non-farm payrolls, suggest a strong labor market and potential economic expansion. This can boost investor confidence and lead to increased demand for the currency, potentially strengthening its value in forex markets.
Employment data is a key indicator of an economy’s health and can shape overall economic expectations. Positive employment data can enhance the economic outlook and raise expectations for future growth, potentially supporting the currency’s value. Conversely, weak employment data can dampen economic expectations and put downward pressure on the currency.
We can keep an eye out for all these economic indicators through Economic calendars.
Economic Calendar
Economic calendars are widely used tools in forex trading to stay informed about upcoming economic events, news releases, and key indicators that can impact currency markets.
Economic calendars provide traders with a comprehensive list of scheduled economic events, such as central bank meetings, GDP releases, employment reports, inflation data, and interest rate decisions.
It’s worth noting that economic calendars are publicly available from various financial websites, trading platforms, and news sources. You can also have access to our Economic Calendar.
Let us see one example from investing.com from June 14, 2023:
Impact assessment:
The likelihood of the intensity of an impact from a news release is categorized as the following:
- High Impact (3 stars): USD – Fed Interest Rate Decision
- Medium Impact (2 stars): JPY – Adjusted Trade Balance
- Low Impact (1 star): NZD – GDP expenditure (QoQ)
Traders can review the calendar to be aware of the timing and importance of these events (as highlighted above), allowing them to prepare and adjust their trading strategies accordingly.
Economic calendars are particularly valuable for news trading strategies. Traders who engage in news trading aim to capitalize on significant market movements that occur immediately after important economic events or data releases. By following the economic calendar, traders can plan their trades in advance, identify potential opportunities, and be prepared to react quickly to market conditions. However, a trader should be extremely cautious while trading news as due to highly volatile movements they often might not get the price at which they would like to execute the position.
Traders should ensure they are using reliable and reputable sources for accurate and timely information. Additionally, while economic calendars are helpful tools, traders should also consider other factors such as technical analysis, market sentiment, and geopolitical events to make well-rounded trading decisions.
Let’s see one example below of the market reaction upon a major news release and how not staying up to date with any high-impact news release can adversely affect the trades:
Economic calendars can help traders manage their risk exposure by highlighting periods of potential high volatility. By being aware of upcoming events with significant market impact, traders can adjust their position sizes, set appropriate stop-loss orders, or even choose to stay out of the market during periods of increased uncertainty.
Political Factors
Political stability and geopolitical events can influence currency values. Fundamental analysis considers factors such as elections, government policies, trade agreements, political unrest, and international relations that can affect the economy and currency markets.
Conclusion
In conclusion, fundamental analysis plays a crucial role in analyzing forex markets. Fundamental analysis allows traders to understand the underlying economic, financial, and geopolitical factors that impact currency values and exchange rates.
By incorporating fundamental analysis into their trading strategies, forex traders can have a more comprehensive view of the market, make informed decisions, and potentially increase their chances of success.