Fundamental analysis in simple words

Fundamental analysis in the Forex market - approach, which allows us to understand the underlying processes that determine the dynamics of a particular currency. As a rule, we are talking about long-term trends. By and large, everything is very simple: the currency of the country with the higher rate of economic growth and the higher interest rate of the Central Bank strengthens in a currency pair. But there are situations when these principles do not work: economic and political crises or natural disasters.

Many traders, especially beginners, refuse the fundamental analysis (FA), because in their opinion it is too haphazard - there is too much different economic information and there is no convenient functionality to formalize it. Today we will try to change your mind, because in fact the basic concepts of FA are very simple and easily applicable in trading.

 

 

Central banks rule the ball

From our point of view, the strongest fundamental factor is monetary policy Central banks. A "soft" policy (low interest rates and unconventional monetary measures) leads to a decline in the currency, while a "hard" policy (high interest rates) leads to its appreciation. The higher the interest rates, the more expensive it becomes for commercial banks to lend to the Central Bank, i.e. the cost of borrowing increases.

Which Central Banks should Forex traders look out for? The most powerful player is the U.S. Federal Reserve System (Fed). Formally, the Fed is a private organization (a joint-stock company with a special status of shares), but in fact it is managed by the state. Since January 2014, Janet Yellen has been the chairman of the U.S. regulator, and her predecessor during the global financial crisis was the notorious Ben Bernanke. It was under his leadership that the interest rate was lowered to a record low in 2008, and then the quantitative easing (QE) program. This was necessary to stimulate economic activity that had fallen after the mortgage crisis. As a result of these measures, the U.S. dollar has depreciated significantly against most world currencies, and a period of "currency wars" began in world currency markets as major regulators injected cheap liquidity into their economies to support activity and depreciate national currencies.

Speaking of central banks, we cannot ignore the European Central Bank (ECB), which determines the monetary policy of all euro zone regulators. The ECB was founded in 1998. Mario Draghi, President of the Bank of Italy, will be at the helm from 2011 to 2019. The ECB was also forced to turn to stimulative policies, and in January 2015 it announced the launch of a QE program along U.S. lines. The Europeans were pushed to such desperate actions by the threat of the currency bloc falling into a deflationary loop. The announcement of the program led to a powerful sale of the European currency.

In addition, separately draw your attention to the concept of divergences in monetary policy. A good illustration is the behavior of the EUR/USD pair in 2014. At that time the Fed, which is responsible for the dollar exchange rate, had already taken the path of policy tightening (QE rollback, rate hikes), as the United States economy recovered from the crisis. Expectations of monetary tightening have been a powerful positive for the USD. Meanwhile, the ECB, which rules the EUR exchange rate, just announced its intention to ease its policy. Expectations of easing led to sales of EUR. As a result, selling the EUR/USD was, in fact, a win-win option to open the short positions for the entire second half of 2014.

As another example of divergence, consider the fall of the Japanese yen (USD/JPY rise) in 2012/13. At that time, the Bank of Japan was conducting aggressive monetary stimulus, while the Fed was preparing to curtail it.

We won't dwell on all the central banks in detail, but hopefully you understood that underestimating their influence on the foreign exchange market is dangerous. You can get detailed information about the regulators' activities at their official websites, and the texts of interest rate decisions and CB meeting minutes in Russian at our website.

As the economy grows, they buy currency.

Another important factor in the demand for currency is the country's economic growth dynamics. Basically, when we compare two currencies we are comparing the economies of two countries, their investment attractiveness and trade potential. Traders use macroeconomic indicators that are regularly published in economic calendar. When important indicators are released (GDP, inflation, unemployment, balance of payments, etc.) there is increased volatility in the currency market. At these moments the market becomes more "dangerous" for newcomers, but also richer in trading opportunities.

Most analysts take a "balanced" view of the analysis methodology. Indeed, it is impossible to determine the right entry point into the market without technical signals. On the other hand, without understanding the fundamental factors, technical indicators make very little sense: a real trader has to feel what moves the market. Good luck in trading!

Articles of the "Fundamental Analysis" Master Class

• Fundamental analysis of Forex: a primer
• Forex Fundamental Analysis: Currency Features Worth Watching
• Fundamental analysis of the Forex market: economic calendar and peculiarities of trading on the news
• Types of currencies on : shelter currencies and commodity currencies
• Models of fundamental analysis and prediction of exchange rates in FOREX