As you have already read, Fundamental analysis is studying the economic fundamentals of a currency, country, or economy. Economic fundamentals really is a very broad term and gives you a huge amount of information to draw upon when conducting your analysis.
But why are economic news releases of this type so important to the value of a country's currency? Well, it all comes down to simple supply and demand.
- If a country's economic outlook is healthy, then this will mean that the investment that businesses will put into the economy should see demand for the currency rise.
- This is then exaggerated by the country's central bank being forced to raise interest rates to control inflation and stop the economy from overheating too quickly.
- When interest rates go up, foreign investors gain more value by investing in assets of that country, creating more demand for the currency and having it's value rise in the process.
As you can see, Fundamental analysis can be very powerful. If you can predict the future health of a country's economy, then you can actually go a long way in predicting the future health of a country's currency!
Don't worry too much if you weren't an economics major at school because funnily enough, the actual numbers or news releases aren't the most important part of fundamental analysis to forex traders. The most important part of any change in fundamentals is how the market EXPECTS it to react.
It's not uncommon for good news to send a country's currency falling like a stone. This may sound strange after reading our definition of fundamental analysis above, but because changes in an economy's fundamentals can take many months to flow through the entire economy, forex markets actually price in these moves before they actually happen.
Forex traders are always trying to stay one step ahead of their competition so market sentiment, or where the market thinks that the fundamentals are going to send price, is actually much more important than the release itself!
The main fundamentals that you as a trader should focus on are explained from here:
- Economic data releases
- Central Bank Decisions
- News Headlines