Fundamental analysis is a way of anticipating price movements in the forex/CFD market by analysing the economic, social, and political forces that may affect the supply and demand of the asset you are trading.
Trading the fundamentals is also referred to as trading the news, as you need to pay close attention to changes in newly released economic indicators such as interest rates, employment rates, and inflation. The end goal of performing fundamental analysis is to discover the true value of an asset, compare it to the current price and locate a trading opportunity. For example, a country with a strong and growing economy will experience stronger demand for its currency, which will work to lessen supply and drive up the value of the currency. So, essentially, it all boils down to the basic principles supply and demand.
Using supply and demand as an indicator of where price could be headed can appear easy. The real challenge however, is analysing all of the factors that affect supply and demand. There are a great number of economic theories which surround fundamental Forex and CFD analysis. Attempting to put various pieces of economic data in context to make them comparable requires a lot of work and discipline.
Forex and CFD Fundamentals
Forex and CFD prices are impacted by macro and micro-economic data, geo-political events and their linkages. These factors may include for example, GDP growth rates, potentially disruptive geopolitical events, employment statistics, interest rates, and balance of trade reports among others. By assessing the relative trend of these data points, a trader is essentially analysing the relative health of the country’s economy and determines the future movement of their currency.
For traders trading stocks CFDs, they look at the company’s most recent earnings reports, expenses, assets, and liabilities. Fundamental traders will use those data points to determine the health of the company. If their economic wellbeing is trending better as their company’s earnings and balance sheet are growing, then a fundamental trader would choose to place a buy position on that firm’s stock in anticipation of demand growing for that stock.
Trading the News
Economic data tends to be one of the most important catalysts for short-term movements in any market, but this is particularly true in the currency market, which can react to news from around the world. Typically, employment reports, interest rate decisions, and GDP numbers are what is considered important news for a country’s currency. These news are important because they can affect monetary decisions by central banks. If the data paint a picture of a strong economy for example, central banks will likely opt to raise interest rates which in turn typically cause their currency to rally. Since the U.S. dollar is on the “other side” of 90% of all currency trades, U.S. economic releases tend to have the most pronounced impact on the market.
When trading the news, a trader needs to know which releases are actually expected that week. Some of the most important economic events that drive Forex price movement include:
- Benchmark Interest Rate Decisions: Central bank rate decisions cause the most volatility in currency pairs, especially when a change in key interest rates was unexpected.
- Inflation Data: The level of the price of goods in a nation can significantly affect central bank monetary policy.
- Key Jobs Data – Unemployment rates and the amount of people receiving benefits for unemployment provides a barometer for a nation’s economic growth. U.S. Non-Farm Payrolls data in particular, is one of the most closely watched economic indicators and can have a substantial market impact.
- Preliminary GDP Data – A country’s gross domestic product is one of the most important measures of an economy’s health and can also encourage monetary changes.
- Trade Balance and Current Account Data – Variations in the balance between a country’s imports and exports has a substantial impact on a currency.
Using News Trading Tools
Market consensus is one of the most important concepts to understand when contemplating trading market news releases. Simply put, consensus refers to the average expectation of financial analysts and market participants for a particular economic report. As many analysts express their views, a general market consensus eventually forms; this is seen as the market “standard” against which the actual result will be measured. If the observed result is better than what analysts were expecting, related assets tend to edge higher in value. On the contrary, if the result turns out to be weaker than market consensus, then investors will be disappointed and prices will likely drop.