While many forex traders focus on technical analysis, fundamental analysis plays an equally important role.
Whereas technical analysis involves poring over charts to identify patterns or trends, fundamental analysis involves poring over economic data reports and news headlines. (And even random tweets from a certain world leader.)
What is Fundamental Analysis in Forex Trading?
Fundamental analysis is a way of looking at the forex market by monitoring economic, social, and political forces that may affect currency prices.
Unlike technical analysis, which relies on historical price data and chart patterns, fundamental analysis looks at the broader economic picture to forecast currency price movements.
It involves analyzing a country’s economic indicators, central bank decisions, political events, and other fundamental factors to predict the future direction of a currency’s price.
Economics 101: It’s All About Supply and Demand
If you think about it, this makes a whole lot of sense! Just like in your Economics 101 class, it is supply and demand that determines price, or in our case, the currency exchange rate.
Using supply and demand as an indicator of where the price could be headed is easy. The hard part is analyzing all of the factors that affect supply and demand.In other words, you have to look at different factors to determine whose economy is rockin’ like a BLACKPINK song, and whose economy sucks.
You have to understand the reasons why and how certain events, like an increase in the unemployment rate affect a country’s economy and monetary policy, which ultimately affects the level of demand for its currency.
The idea behind this type of analysis is that if a country’s current or future economic outlook is good, its currency should strengthen.
The better shape a country’s economy is, the more foreign businesses and investors will invest in that country. This results in the need to purchase that country’s currency to obtain those assets.
The logic is straightforward: Strong economy = More foreign investment = Higher demand for currency = Currency value goes up 📈
In a nutshell, this is what fundamental analysis is:
How This Works in Real Life
Let’s break this down with a real-world example:
Let’s say that the U.S. dollar has been gaining strength because the U.S. economy is improving.
What happens next? The Federal Reserve (aka “the Fed”) starts thinking about raising interest rates to keep the economy from overheating.Higher interest rates make dollar-denominated financial assets more attractive.
But here’s the catch: to buy these dollar assets, traders need actual dollars first! This increases demand for the U.S. dollar, driving its value up against currencies from countries with lower interest rates or weaker economic outlooks.
Remember: currencies always come in pairs. The USD doesn’t just strengthen in a vacuum, it strengthens relative to another currency that’s relatively weaker.
Later on in the course, you will learn which economic data points tend to drive currency prices, and why they do so.
You’ll become familiar with economic indicators such as GDP, inflation rates, consumer confidence surveys, and employment figures.
You will know who the Fed Chairman is and how retail sales data reflects the economy. You’ll be spitting out global interest rates like song lyrics.To be able to use fundamental analysis, it is essential to understand how economic, financial, and political news will impact currency exchange rates.
This requires a good understanding of macroeconomics and geopolitics.
No need to be intimidated by such fancy-sounding words, though. Yes, terms like “macroeconomics” and “geopolitics” sound like they belong in a university lecture hall, but don’t let fancy terminology scare you off.
For now, just know that fundamental analysis is a way of analyzing the potential moves of a currency through the strength or weakness of that country’s economic outlook.
Once you get the hang of connecting economic dots to currency movements, you’ll see the forex market in a whole new light. It’s going to be awesome, we promise!
