Welcome to Lesson 6: Fundamental Analysis. As we have spoken about in a previous lesson, Fundamental Analysis is the process by which one uses the Forex News in order to make their trading decisions.
Understanding Fundamental Analysis is an integral part of trading the Forex Market, in this lesson we will be looking at; How we can keep up to date and make sense of the news in an easy/efficient way, How to assess the importance of news events, What news events will have an impact on the Currency Pair you are looking to trade and finally my thoughts on trading the Forex news.
What is Fundamental Analysis?
Okay, so let’s start by actually breaking Fundamental Analysis down, so that we can make sense of it. We have already learnt that in Forex, we are trading Currency Pairs. These Currency Pairs will rise or fall, depending on traders reactions/emotions towards global economic news and other events that affect the financial markets.
The basic concept behind Fundamental Analysis is that if a country’s present or future economic outlook is weak, then that countries currency should weaken as a result. If a country’s present or future economic outlook is strong, then that countries currency should strengthen as a result.
So technically it comes down to supply and demand. Think about it, it would not be a great idea to start a business in a country, where the economy has been weakening. It would be better to start a business in a country, where the economy is booming and on the rise. So it is in fact a strong economy that will attract investment, as they will experience a higher demand for their currency and that higher demand in turn will drive up the currency value.
Let’s put all this information into an example, so we can make sense of it:
If the economy for Great Britain is on the rise and it is gaining more and more strength, then the value of the GBP (Great British Pound) will rise in relation to other currencies, one of the main reasons for this is because as the country’s economy strengthens, they will usually raise their interest rates in order to keep the growth and inflation in balance.
These higher interest rates will attract investors, and so as they buy the GBP (in order to invest in Great Britain) this will cause a rise in demand and an increase in value for the GBP.
How to assess Global Economic News
It would be quite difficult to try and keep up with the Worlds economic affairs every single day, you would first have to gather the news by doing your research, identify the time/s at which the report is due to be released, assess the impact it may have on different Currency Pairs and this is all before you have even thought about taking a trade! Well fear not, all this hard work has already been done for you.
Traders are able to keep an eye on the news, by using an Economic Calendar. The Economic Calendar shows all the upcoming news and is broken down into different columns.
By looking at the Economic Calendar above, we can see the following information:
TIME: This shows when the Event/Report is due to be released. It is important to ensure that when viewing the Economic Calendar, you are doing so using the correct timezone for where you are currently located.
EVENT: This is the name of the economic event that is due to be released, along with the currency that relates to the event. So for example, you can see that at 12:00 we see; ‘MBA Mortgage Applications (Nov 15)’ for the USD.
VOLUME: This is one of the most important elements of the Economic Calendar. Different events will have varying impacts on the currency, these are shown on the calendar by yellow, orange and red indicators.
Yellow = LOW volatility expected
Orange = MEDIUM volatility expected
Red = HIGH volatility expected
Let’s view some examples:
The 13:30 CAD news has a low volatility symbol. This means that the CAD is not going to be affected much at all, and as a result there will be very low to no movement for the CAD related to this event.
The 12:00 USD news has a medium volatility symbol. This means that the USD will be affected, but not to any major degree. So a medium movement for the USD is expected in relation to this event.
Finally the 10:00 GBP news has a high volatility symbol. This means that the GBP will be affected by the event in a very strong way. A big move is expected for the GBP at this time, proceed with caution.
ACTUAL, CONSENSUS and PREVIOUS: News events will be measured by a figure, these can vary from; percentages, decimals, whole numbers, K (Thousand), M (Million) and B (Billion). Let’s look at what the different headings represent:
PREVIOUS – This is what the event came out to be when it was previously released. Note MoM stands for Month on Month and YoY stands for Year on Year.
CONSENSUS – This figure represents what the new figure is predicted to be.
ACTUAL – This is the actual figure for the given event.
Okay, so now that we have analysed the Economic Calendar column by column, you should now be comfortable with all the information that it displays. We can now move on to answering the following questions; How do I know what events to look out for? Will all the events on the Economic Calendar affect my Currency Pair or just some of them? If so, which ones?
In the next section we will be answering these questions, and you will have a sharper understanding of how to actually use the Economic Calendar to your advantage.
What events will affect the Currency Pair I want to trade?
This is actually very simple indeed, to answer this you must remember what we spoke about way back in Lesson 2:
“The first currency in the pair is known as the Base Currency, the second currency in the pair is referred to as the Counter Currency.”
The events that will affect the Currency Pair you are looking to trade, will be the events that relate to it. For example:
I am looking to trade the GBP/USD.
The events that will affect this Currency Pair are going to be the GBP News and the USD News.
That really is how simple it is to identify. Now remember, the Base Currency is the first currency in the pair, so in our example this is the GBP. The Counter Currency is the second currency in the pair, so this would be the USD. What you see when you look at the chart is a movement of the Base Currency against the Counter Currency.
So if there was a High volatility news event for the GBP, due to be released and it came out to be positive for the GBP, then the GBP/USD would shoot up. If there was a High volatility news event for the USD, that also came out to be positive then the GBP/USD would go down. It would go down because remember, the chart is showing us movement of the base currency against the counter currency, if the counter currency strengthens then the base currency will weaken in comparison to it.
How do I trade Fundamental Analysis?
At the beginning of this lesson, I said I was going to offer my thoughts on Fundamental Analysis. Well here is my advise, do NOT trade Fundamental Analysis! Let me be a bit more clear, do NOT trade Fundamental Analysis on it’s own!!
Novice traders often look at Fundamental Analysis as an opportunity to make a lot of PIPS. They see that High volatility news has the potential to move the market, sometimes by 100 PIPS. The reality is, if it was that easy then everyone would be Billionaires. In fact, it is not easy and very very risky. You can not tell the future and so you don’t actually know which way the market will move, it is not uncommon for traders to blow out their account because of a silly move like trying to trade the news and then having the trade move against them by many PIPS, effectively putting an end to their Forex career (or a move back to square one and no funds).
So I hear you ask, has this entire lesson been in vain? No, of course not!
You see, now we know when NOT to trade (High volatility events). We do NOT want to open a trade or still be in a trade, when a High volatile event is released, this is far too risky, and you may wipe out your account. Trading is all about capital preservation fist and making a profit after. You live to trade another day.
So we have covered Fundamental Analysis, In the next lesson we are going to be looking at Technical Analysis. That is where things really open up!
See you there!