Fundamental analysis is just exactly what it says – fundamental to understand the reasons why any tradable instrument moves in value. Some – such as government bond values, are simple to understand, the reasons why currencies and shares rise or fall in value are also reasonably easy to understand too as long as the factors of fundamental analysis are understood.
How many novice traders thought they analyzed the fundamentals of a certain trading setup properly and still lost when they executed the trade? How many of these same novice traders went back to their books and found out what went wrong on that trade? That’s why currency trading needs both technical analysis supported by proper fundamental analysis, as well as studying the history of the price movement and reviewing trading reports to take account of small variants that will improve your trading in the Forex market.
The main reason currencies fluctuate in value is economic releases. Below are the main factors of fundamental analysis
1- Interest Rate Differentials
The interest rate is among the important factors of fundamental analysis. If one country offers a higher rate of interest than another on simple investment instruments and both countries are considered economically and politically stable, then common sense says that the one with the higher interest rate will attract more overseas money. By the simple law of supply and demand, purchasing that country’s currency to invest will push its exchange rate higher.
2- Inflation Differentials
Inflation has a negative effect on the purchasing power and it depreciates the value of a currency. Low inflation countries tend to have better exchange rates so, in theory, following a currency whose government wants to keep the inflation rate low will be positive on your trading.
3- Current Account Deficits
If a country continually buys more from other countries than it sells to them it will have to finance the difference by selling its own currency in the form of treasuries and government bonds, therefore, the currency value will depreciate as the law of supply and demand states that if supply is higher than the demand for a currency then its value will depreciate. There is usually a baseline for how far it will fall as eventually the cost of goods and services become so cheap other countries will buy more of them, reducing the deficit and by virtue of having to buy the currency to pay for its goods and services, the value of the currency will rise again.
4- Debt Financing
If a country continually runs budget or trade balance deficits, it will eventually have to finance that through borrowing and repay the interest and installments accrued in foreign currency, selling its own, which will reduce its value. Large debts also worry international investors and traders and so they could sell that country’s currency, expecting a decrease in its value.
5- Political Stability
Political stability is very important in helping investors remain assured that their money is safe. Stable politics mean the chance for economic policies to work. Political stability can affect a country’s credit rating through the impact perception of stability has on its government bonds’ values.
For the trader, the difficulty is in weighing up just how much of an impact these factors will have on a currency and how much one is countered by another. Understanding factors of fundamental analysis is essential for all that traders and speculators to help making their trading decisions, with the popularity of technical indicators and the increasing technological advancements in social trading, the art of fundamental analysis is becoming more valued as economic releases dominate the market sentiment.