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Forex analysis is used by traders to determine whether to long or short a respective currency pair.
Fundamental analysis is a type of Forex analysis which attempts to measure a currency’s value by examining related economic and financial factors, which can be both qualitative and quantitative in nature.
There are loads of different fundamental analysis indicators that are used by traders.
In Forex trading, an indicator is a technical tool used to predict future price movement.
Let’s have a look at three of the most popular fundamental ‘indicators’ that are utilised by traders.
Inflation is the sustained increase in the amount of currency in circulation – which in turn can increase the price of goods and services in the related economy.
With this in mind, inflation is one of the most influential fundamental indicators amongst Forex traders as it demonstrates how healthy a currency’s economy is.
It is important to understand that even through the power of their central banks, governments do not have much control on their country’s inflation rates.
Depending on whether the inflation rate is above or below the governments set target, the country can be in a state of hyperinflation – whereby too much money has been introduced into circulation, or negative inflation – which means that there is too little money in circulation.
If a country is considered to be in hyperinflation, the currency will decrease in value, since there is a bigger supply of the currency than there is demand for.
Conversely, if a country is in negative inflation, this means that there is a larger demand for the currency than there is supply, which will lead to the currency increasing in value.
Interest rates are related to the value charged by central banks for lending money to private banks. This charge in turn, is passed by the private banks down to the public. Interest rates are a primary tool used to regulate inflation. Interest rates are set by central banks, who usually notify the public of changes in the interest rate in advance during press conferences, to avoid unnecessary market turmoil.
Traders tend to trade before official interest rate announcements, they do this in anticipation of a market move when the interest rate decision is made. The dates of interest rates announcements are usually announced in advance, which are shown on our economic calendar.
In a well regulated, well balanced economy, central banks may increase interest rates in order to slow the pace of lending, and to ‘cool down’ an economy by decreasing inflation. This cuts consumer spending, helping to bring growth to a more manageable level.
Conversely, if the government is eager to spur the economy, they can decrease interest rates, making it easier and cheaper for businesses and individuals to borrow money.
Therefore, an increase in interest rates generally forces a currency to increase in value, since there is a decrease in supply and an increase in demand.
Conversely, a decrease in interest rates means there is an increase in supply and decrease in demand, which in turn decreases the currency’s value.
Gross Domestic Product (GDP)
Gross domestic product (GDP) measures the total value of all goods and services produced in a country within a given period. GDP is considered to be one of the best overall fundamental indicators of a currency. A growth in GDP indicates economic growth therefore a currency should increase in price, and vice versa.
If GDP movement is in line with other fundamental indicators – such as the Consumer Price Index (CPI) – and within an anticipated range, it hints at economic strength and an increase in the currency’s value. A disparity in this pace of increased GDP would hint at a potential decrease in value of the currency.
Lets look at an historic example of how you could have utilised fundamental analysis, below.
After the 2007-2009 financial crisis, the Australian economy stood firm and did not hit a recession, unlike its western counterparts. What fundamental indicators showed this?
Interest rates recovered the quickest out of all the typically strong economies.
Australian GDP rates steadily increased along with property prices.
As a result many foreign investors wanted to benefit from this upside. When investing within the country, foreign investors had to first exchange their respective currency into Australian dollars.
As a result, the fundamental indicators showed positive signs for the Australian dollar, which turned out to be correct as the Australian dollar experienced multi year growth, as seen in the chart below.
A good economy generally signals a higher currency value, while a bad economy signals a lower currency value.
This is because the better shape a country’s economy is in, the more foreign businesses and investors will likely invest in that country.
This causes a higher demand for the local currency to purchase assets within that particular country’s economy.
– Forex analysis is used by traders to determine whether to long or short a respective currency pair.
– In Forex trading, an indicator is a technical tool used to predict future price movement.
– Fundamental analysis is a process that attempts to measure a currency’s value by examining related economic and financial factors, which can be both qualitative and quantitative in nature.
– There are loads of different fundamental analysis indicators that are used by traders.
– Three of most popular fundamental ‘indicators’ that traders utilise are;
- Interest Rates
- Gross Domestic Product (GDP)