Along your travels, you’ve undoubtedly come across Gulliver, Frodo, and the topic of fundamental analysis.
Wait a minute…
We’ve already given you a teaser about fundamental analysis during Kindergarten! Now let’s get to the nitty-gritty!
What is it exactly and will I need to use it? Well, fundamental analysis is the study of fundamentals! That was easy, wasn’t it? Ha! Gotcha!
There’s really more to it than that. Soooo much more.
Whenever you hear people mention fundamentals, they’re really talking about the economic fundamentals of a currency’s host country or economy.
Economic fundamentals cover a vast collection of information – whether in the form of economic, political or environmental reports, data, announcements or events.
Even a credit rating downgrade qualifies as fundamental data and you should see how Pipcrawler turned this news into a winning short EUR/USD trade.
Fundamental analysis is the use and study of these factors to forecast future price movements of currencies.
It is the study of what’s going on in the world and around us, economically and financially speaking, and it tends to focus on how macroeconomic elements (such as the growth of the economy, inflation, unemployment) affect whatever we’re trading.
Fundamental Data and Its Many Forms
In particular, fundamental analysis provides insight into how price action “should” or may react to a certain economic event.
Fundamental data takes shape in many different forms.
It can appear as a report released by the Fed on U.S. existing home sales. It can also exist in the possibility that the European Central Bank will change its monetary policy.
The release of this data to the public often changes the economic landscape (or better yet, the economic mindset), creating a reaction from investors and speculators.
There are even instances when no specific report has been released, but the anticipation of such a report happening is another example of fundamentals.
Speculations of interest rate hikes can be “priced in” hours or even days before the actual interest rate statement.
In fact, currency pairs have been known to sometimes move 100 pips just moments before major economic news, making for a profitable time to trade for the brave.
That’s why many forex traders are often on their toes prior to certain economic releases and you should be too!
Generally, economic indicators make up a large portion of data used in fundamental analysis. Like a fire alarm sounding when it detects smoke or feels heat, economic indicators provide some insight into how well a country’s economy is doing.
While it’s important to know the numerical value of an indicator, equally as important is the market’s anticipation and prediction of that value.
Understanding the resulting impact of the actual figure in relation to the forecasted figure is the most important part. These factors all need consideration when deciding to trade.
Don’t worry. It’s simpler than it sounds and you won’t need to know rocket science to figure it all out.
I suggest you visit Pip Diddy’s daily economic roundup every day so that you can stay in the loop with the upcoming economic releases.
Fundamental analysis is a valuable tool in estimating the future conditions of an economy, but not so much for predicting currency price direction.
This type of analysis has a lot of gray areas because fundamental information in the form of reports releases or monetary policy change announcements is vaguer than actual technical indicators.
Analysis of economic releases and reports of fundamental data usually go something like this: