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Fundamental Analysis in Forex

At this point, you already know how the Forex market works and how to place trades. But how do you decide which trades to take? This is where market analysis comes in.

There are two main types of analysis: Fundamental Analysis and Technical Analysis.

In this lesson, we’ll focus on fundamental analysis, a method that helps you understand why currencies move the way they do.

What Is Fundamental Analysis?

Fundamental analysis looks at real-world factors that impact a currency’s value. These factors can be:

• Economic (GDP, inflation, interest rates)

• Political (elections, government policies)

• Geopolitical (wars, trade disputes, sanctions)

Example: If the U.S. economy is booming, investors will want U.S. assets, increasing demand for the USD and pushing its value up.

But if inflation gets too high, the U.S. Federal Reserve might raise interest rates to slow it down, affecting the currency differently.

Fundamental analysis helps traders anticipate these movements and make informed trading decisions.

What Is the Role of Economic Indicators in Fundamental Analysis?

Economic indicators are like the pulse of a country's economy, providing invaluable insights into its health and performance.

Therefore, understanding these indicators is crucial when Forex trading as they serve as key drivers of currency movements.

Let's explore some of the most crucial economic indicators and their significance in fundamental analysis.

Gross Domestic Product (GDP)

GDP represents the total value of all goods and services produced within a country over a specific time period. It’s one of the most watched indicators in Forex.

• Strong GDP growth → Signals a healthy economy → Currency appreciates.

• Weak GDP growth or recession → Signals economic trouble → Currency depreciates.

Example: If U.S. GDP is strong while the Eurozone’s is slowing down, EUR/USD might decline, meaning the USD is strengthening against the Euro.

Employment Indicators

A strong job market indicates a growing economy, leading to currency appreciation.

Key employment indicators include:

• Non-Farm Payrolls (NFP): U.S. job growth report.

• Unemployment Rate: Percentage of unemployed workers.

• Jobless Claims: Number of people applying for unemployment benefits.

Example: If the U.S. reports higher-than-expected job growth, traders might anticipate an interest rate hike, boosting the USD.

Inflation Measures

Inflation measures how fast prices are rising. The two main inflation indicators are:

• Consumer Price Index (CPI): Measures price changes in everyday goods.

• Producer Price Index (PPI): Tracks changes in wholesale prices.

Why does this matter?

• Low inflation → More purchasing power → Currency strengthens.

• High inflation → Erodes currency value → Currency weakens.

Example: If inflation in the U.K. is rising, the Bank of England might raise interest rates to control it, making GBP more attractive to investors.

Trade Balance

A country’s trade balance shows the difference between exports (goods sold abroad) and imports (goods bought from abroad).

• Trade surplus (exports > imports) → Increases demand for the currency → Appreciation.

• Trade deficit (imports > exports) → More money leaving the country → Depreciation.

Example: If China exports more than it imports, demand for CNY (Chinese Yuan) rises, strengthening its currency.

What Is the Role of Geopolitical Events in Forex Trading

Currencies don’t just respond to economic numbers; political and global events can shake the Forex market too.

Political Instability and Uncertainty

Elections, leadership changes, and political uncertainty make investors nervous. Traders avoid risk and move their money to more stable currencies.

For example, before major elections, investors may sell off a country’s currency due to uncertainty about new policies.

Geopolitical Conflicts and Terrorism

Wars, terrorism, and international disputes create uncertainty, leading traders to shift toward safe-haven currencies, such as:

• USD (U.S. Dollar): The world’s most widely used currency.

• JPY (Japanese Yen): Historically stable during crises.

• CHF (Swiss Franc): Switzerland’s stable economy makes it a go-to during global instability.

For example, if tensions rise in the Middle East, traders might sell riskier currencies and buy USD or CHF instead.

Economic Sanctions

Sanctions and trade restrictions impact global economies, weakening the targeted country’s currency.

Sanctions may target specific industries or sectors of the sanctioned country's economy, affecting its trade balance, investment inflows, and overall economic performance.

Example: Fundamental Analysis of EUR/USD Trade

We take a real-life example to better understand how to use fundamental analysis within a trade.

Let's say we're considering a long position on the EUR/USD currency pair based on fundamental analysis.

Step One: Check the Economic Calendar

First, we consult the economic calendar and note that the European Central Bank (ECB) is scheduled to announce its interest rate decision and provide forward guidance on monetary policy.

Step Two: Research the Economic Indicators

Second, we have to research the economic indicators, as we mentioned above, how impactful they are.

So, we dive deeper into the economic indicators relevant to the Eurozone and the United States, such as:

• GDP growth

• Inflation rates

• Employment figures

We also consider any geopolitical developments or trade tensions that may impact the EUR/USD exchange rate.

Step Three: Analyze ECB's Monetary Policy

Then, before the ECB meeting, we review recent statements from ECB officials and market expectations regarding potential policy changes.

We assess whether the ECB will likely maintain its current policy stance, signal a shift in monetary policy, or provide hints about future actions.

Step Four: Understand the Market Sentiment

Next, we sense market sentiment by monitoring news headlines, analyst reports, and social media discussions related to the EUR/USD pair.

Positive news will lead to currency appreciation, while negative developments could weigh on the currency.

Step Five: Decision Making

Based on our analysis, if we anticipate that the ECB will maintain its accommodative monetary policy stance and possibly signal optimism about economic recovery in the Eurozone, we may decide to go long on EUR/USD ahead of the ECB meeting.

Then, we make sure we have risk management measures set in place, such as setting stop-loss orders to limit potential losses in case the trade goes against us. We also consider position sizing based on our risk tolerance and account size.

Step Six: Executing and Monitoring

On the day of the ECB meeting, we execute the trade according to our plan. We closely monitor market reactions to the ECB's announcement and adjust our trade if necessary based on incoming information and price action.

Step Seven: Evaluation

After the trade is closed, we evaluate the outcome, analyzing factors that influenced the trade's success or failure. We learn from our experience to refine our fundamental analysis approach for future trades.

Lesson Summary

• Fundamental analysis examines economic, political, and social factors that affect currency prices.

• Key economic indicators include GDP, employment data, inflation, and trade balance.

• Geopolitical factors such as elections, conflicts, and trade wars also influence Forex markets.

• A strong fundamental analysis strategy includes researching economic data, central bank policies, and market sentiment before making a trade.

Now that you understand why currencies move, it’s time to learn how to analyze price charts using technical analysis in the next lesson!