Currency Trading Basics: the Application of Fundamental Analysis
What is Fundamental Analysis?
Fundamental analysis utilizes economic fact to predict currency reality. Its premise is that the value of a currency is determined by the comparative strengths and weaknesses of a country’s economy in relation to those of its trading partners. The economy with higher GDP growth, lower inflation, higher interest rates, greater productivity and political stability and a host of other factors will, over time, have the stronger currency.
It is fundamental factors that produce the long lasting price trends typical of the currency markets. The horizon of fundamental analysis is the longest of all the analytical and statistical tools used to understand currency movements.
National economies are large, complicated and unwieldy entities. Changes in economic trends are enacted over long time periods and can be cyclical or structural. Even central bank interest rate policy, the most common of the fundamental variations in a national economy, takes six to eighteen months to exert its effects.
Some factors which affect a country’s economic status reflect the choices of the political system, the balance between social welfare or individual competition is one example, the openness of an economy to foreign trade and capital is another. Other economic factors such as productivity, labor mobility, entrepreneurship are part of the social and cultural makeup of the nation. And yet others, as oil or mineral deposits, stem from a nation’s geographic or resource endowment.
All of theses factors, and many more, are monitored, assessed and judged for their effect on economic growth and development. A change in one factor or several can affect the productivity capacity of an economy, alter its competitiveness and change the relative value of its currency.
Economic statistics are the window through which fundamental analysis views an economy and its currency. Most statistics have a restricted angle of view; they depict a particular area or sector of an economy. A few depict the economy as a whole.
In a large, diverse modern economy it can be difficult to tease out the most important factors and the most pertinent statistics. Different statistics may point in opposite directions, one area of an economy may be growing while another falters, or the importance of one industry declines as another rises.
Most statistics are also retrograde, that is they will tell you what has already happened but may or may not be an accurate guide to the future. They are few, many analysts would say no, reliably predictive statistics.
Judgment and experience are necessary to complete the picture. In our interconnected and volatile world political, military, human, technological and even natural events can have rapid, vast and long lasting repercussions. These too must be incorporated into an analysts world view.
A fundamental analyst must place all this information in its proper place to create an overall picture of an economy, its strengths, weaknesses, vulnerabilities and, most importantly, its future potential and the likely future course of its currency. This picture is the set of assumptions that that provide the analytic framework for all trading decisions.
Chief Market Strategist