Fundamental analysis in forex trading is an approach of looking at the market by studying the economic, social, and political issues that can affect the value of a currency.

Traders using fundamental analysis as the basis for making trade decisions hold that the strength or weakness of a currency is reflected by its macroeconomic condition; that is, a country with a good economic outlook will have a higher currency value while a country with a bad economic outlook will have a lower currency value.

The economic outlook of a country is usually given by various indicators. Fundamental analysts usually assess how the major political and economic announcements affect the strength of currencies in the forex market.

Major announcements affecting the economic situation of a country released by government officials are often interpreted by traders and used in gauging whether the country’s currency will either appreciate or depreciate in the near future.

There are two main types of economic announcements:

1. Scheduled economic reports

2. Unscheduled economic reports

1. Scheduled economic reports

The release of scheduled economic reports is usually the basis of carrying out fundamental analysis in the forex market.

Traders usually keep an eye on these reports before and after their release in order to speculate on the trend the market is likely to take.

In general, how the participants in the forex market will digest this data and its perceived effect will determine the direction the market will take.

Therefore, the work of a fundamental analyst is to gauge whether the figures in the reports are better than, worse than, or according to the expectations before deciding on what effect they may have on the value of currencies.

Sometimes, the released figures are higher or lower than the prior expectations of the market. As a result, this often leads to an increased level of volatility in the market as traders hurriedly re-balance their positions.

In summary:

• If a release is positive, it reflects robustness in the economy of a country and this tends to cause the value of a currency to appreciate
• If a release is negative or in line with expectations, it will tend to have a negative or a neutral effect on the value of a currency

Here are some important scheduled economic reports that move the forex market:

i. Interest rates

Interest rates are considered as perhaps the most influential mover of currencies in the forex market.

Interest rates, which are set by Central Banks, represent the level of yield paid in return for holding an underlying currency.

The rates are important in controlling the speed of economic development and in controlling the level of inflation.

If the interest rates are low, many people would borrow money and thus the economy would grow.

On the other hand, higher interest rates make the cost of borrowing to be high and this would slow the pace of economic development.

If a Central Bank of a country increases the interest rates, then the yield for holding the currency would also increase.

As a result, this would make the currency more attractive to hold as compared to its peers; consequently, its value would appreciate.

On the other hand, if the interest rates are decreased, then there would be less incentive for traders to hold it; consequently, its value would depreciate.

ii. Economic indicators

Economic indicators portray the general health of the economy of a country. When the indicators are positive or rising, it normally signifies good overall economic condition of a country.

A natural result of this is to attract increased investment into the domestic economy and this would assist in raising the value of a currency.

Some of the economic indicators closely observed in forex trading include Gross Domestic Product (GDP), Gross National Product (GNP), Consumer spending, capital expenditure, and government expenditure.

iii. Inflation rates

Inflation refers to the general rise of prices of goods and services in a country over certain duration of time. The level of inflation in an economy is used to gauge its underlying economic growth; therefore, Central Banks usually keep the level in check to control monetary flow in the economy.

If a country has high level of inflation, it means it has a low level of purchasing power and therefore a weak currency.

To make the value of such a currency stronger, the Central Bank of the country may make a decision to increase the interest rates.

iv. Employment indicators

Employment reports give an indication of the economic health of a country. If more people are getting jobs, it signifies that the economy is expanding.

On the other hand, if the employment figures are low, it signifies that the economy is performing poorly.

An example of a major employment indicator is the Non-Farm Payrolls. It is usually released on a monthly basis in the U.S. and it plays a significant role in determining the value of currencies in the forex market.

v. Balance of Trade reports

Balance of Trade (BOT) refers to the difference between the imports and exports of a country.

If a country has a positive BOT, this often translates to it having a strong currency. On the other hand, if a country has a negative BOT, this often translates to it having a weak currency.

2. Unscheduled economic events

In addition to looking at scheduled economic events, traders who use fundamental analysis also look at unscheduled economic events in making decisions while trading forex.

Unscheduled economic events encompass everything that is not specifically planned to be announced to the market.

This comprises of various worldwide events such as political uncertainties, wars, elections, natural catastrophes, and terrorist acts.

Just like in any other financial market, the foreign exchange market does not like uncertainty. Therefore, when these events take place, they often cause a rapid and dramatic change in sentiment.

A good illustration of this is the correlation between the oil price and the Canadian Dollar (CAD) in which the value of the currency increases as the price of oil increases.

Canada is one of the largest producers of oil in the world; thus, its dependence on this commodity largely affects the value of its currency. As such, any event that can make the price of oil to rise or fall will be reflected in the value of the currency.

Summary

If you want to carry out fundamental analysis as the basis of making your trade decisions, then it is important that you do not confuse yourself with a lot of information.

You should keep it as simple as possible and only use a simple analysis. If you keep your analysis simple, your results will be more helpful and useful.

You should also avoid basing your results on information derived previously because such information may or may not be relevant at the moment.

It is of essence to note that your fundamental analysis focuses on present information only. Do not neglect events that are expected to take place because at times they also determine the trend the market is likely to take.

You should commence trading after you have done a thorough fundamental analysis and the market is starting to portray a clear trend.