Fundamental analysis, unlike technical analysis, is based on assumptions about possible changes in the market that would be caused by various fundamental economic factors. On the contrary, technical analysis only studies the dynamics of the changes themselves; in other words, it analyzes the prices. Thus it becomes apparent that fundamental analysis is completely inapplicable to short-term trading. Besides, it is considered rather cumbersome and complicated – and with good reason – since accurate analysis and conclusions sometimes require up to twenty and even fifty indicators. These may be closely related – or completely contradictory. Without a doubt, a novice trader will be hard put to make sense of it all on his or her own, therefore fundamental analysis is more often used by experienced players. Very often, many fall for the common misconception that fundamental analysis is reduced to waiting for the next global news, or an economic or political event or occurrence. This is not quite so, even if these major market indicators are undoubtedly very important. The most significant indicators in fundamental analysis are: GDP levels of countries and other indicators reflecting growth or decline of a national economy. Trade balance. Money supply in the domestic market. Inflation rate and inflation risks. Benchmark interest rates. Confidence in a national currency on the world market. Major employment indicators, etc. This is just a small portion of the data that traders use in performing fundamental analysis. At the same time, these above are an absolute necessity if engaging in this type of analysis. Even newbie traders are well aware of the fact that success of trading for the most part depends on the strength of the market dynamics; the strength itself is determined by the fluctuations caused by economic and political changes. Thus, fundamental analysis can only determine a direction of the trend depending on the factors that become pivotal at a given timespan. Economic indicators at times exert enormous pressure on the forex market and its behavior. This is why all traders without exception need to pay special attention to the economic calendar and closely follow the events and indicators that may alter the level of volatility and at the same time are pivotal for trend formation. Fundamental analysis utilizes economic news as input data and considers them from the perspective of macroeconomic theories. Macroeconomic indicators are published daily, but not all of them are equally important to the analysis. Furthermore, many macroeconomic indicators are derivatives of the main indicator, GDP of a certain country or the world. However, they all need to be known and analyzed, so let us have a look at each of them individually.
GDP. The gross domestic product is the value of all goods and services produced in a country over the accounting period. Annual GDP is of utmost importance, and not the indicator itself but its changes happening over certain timespans of the year. GDP dynamics largely defines the health of a national economy, its robustness and its capacity to resist various crises. In an ideal world, the economy of any country must demonstrate continuing growth; if the opposite, it is said to be in a period of stagnation.
Essentially, fundamental analysis of the GDP level depends a lot on the balance of demand and supply for domestically produced goods. Growth in supply does not necessarily cause an increase in demand. Such cases are called economic bubbles. They are no less dangerous than stagnation. As you can see, fundamental analysis cannot be limited to meagre analysis of the GDP level as there is a bevy of other intrinsic factors of influence.
Inflation rate. Inflation, in a simplified form, is the relation of supply and demand in monetary terms inside a certain state. The inflation indicator is appreciation of a certain consumer basket. The reasons for this appreciation, however, may vary greatly. Therefore it is more important for fundamental analysis to understand the underlying prerequisites of the ongoing, rather than the resulting total numbers. Furthermore, each individual country, depending on its current status, defines its own acceptable inflation rate that is subject to change if affected by unique factors. These factors are actually more indicative. Therefore, the factor decisive for traders is not the inflation rate itself but by how much it differs from the planned and projected rate. This is also called an inflation delta. In a classic market, a higher inflation rate would mean depreciation of the national currency. The opposite is known to have happened, but these were exceptions from the rule.
Benchmark interest rate (also known as the key interest rate). This is something of a rate defined by a country’s central bank (its chief regulator) and charged to all other commercial banks for “use” of its currency. The key interest defines all consequent rates, from mortgage to short-term loans. For a country’s chief regulator, the benchmark interest rate is the main instrument for controlling the financial environment. The higher the rate, the fewer the number of loans in the country, thus leading to a lower inflation rate. Notice that the inflation rate and the associated interest rate are the cornerstones of fundamental analysis.
Unemployment rate. This indicator is very important in fundamental analysis since it is most closely interlinked with a country’s GDP and affects it directly. It is pretty straightforward: able-bodied but unemployed population is a sizeable burden on the country’s budget that is determined from GDP indicators. However, unemployment indicators indirectly affect the analysis.
Trade balance. It is defined as a relation between a country’s exports and imports. A trade surplus means that the total value of exported goods is higher than that of imported goods, and the country sells more than it buys. This signifies a strong and independent national economy. A trade deficit, on the contrary, means more goods are bought than sold. Therefore, the country’s economy depends on economies of other countries, which is certainly not too good. It is also obvious that the more imports in a trade deficit, the larger the burden of the country’s budget, which in its turn, makes the economy as a whole more fragile.
Balance of payments. This is the household income level in relation to the expenditure level of a separate country as a whole. While balancing the year, the government may make a decision as to whether to increase or decrease its obligations to the partners, i.e. whether to increase the negative or positive balance.
Purchasing power parity. The PPP is rightfully considered one of the best fundamental indicators for the analysis, for it indicates general trends of economic development and facilitates establishment of the real value of the national currency. The PPP helps traders assess the value of the same goods in different countries. Besides, the difference in prices may serve as a basis for further analysis of the inflation rate and inflation risks.
Interest rate parity. This is considered to be the indicator most accessible for analysis of all existing fundamental indicators. It functions on the principle similar to that of the PPP, only based on the key interest rate of the country specified by its central bank. If the rates do not match, there is an imbalance in the yield of the financial instruments in possession of the chief regulator, e.g. of the government bonds.
Consumer price index. This quantifies the value of goods and services produced in a country without relation to the core PPI index. Essentially, it helps in objective assessment of the rate of growth or decline of prices in the country. Special attention is paid specifically to the deviations from expected numbers.
Consumer confidence index. Consumer confidence reflects the consumer sentiment. If the consumers have job security and are optimistic about the future, they are prone to spend more, which, in its turn, promotes economic growth. Optimism and pessimism are the main estimation indicators when determining prospects of further development of the country. Most often, strong consumer confidence signifies possible growth, which would influence formation of a bullish attitude in the market.
To summarize, it should be pointed out that all indicators of fundamental analysis must be considered jointly and in conjunction, and not separately. Besides, it is best to verify your analysis on a demo account before commencing real trading.
GDP. The gross domestic product is the value of all goods and services produced in a country over the accounting period. Annual GDP is of utmost importance, and not the indicator itself but its changes happening over certain timespans of the year. GDP dynamics largely defines the health of a national economy, its robustness and its capacity to resist various crises. In an ideal world, the economy of any country must demonstrate continuing growth; if the opposite, it is said to be in a period of stagnation.
Essentially, fundamental analysis of the GDP level depends a lot on the balance of demand and supply for domestically produced goods. Growth in supply does not necessarily cause an increase in demand. Such cases are called economic bubbles. They are no less dangerous than stagnation. As you can see, fundamental analysis cannot be limited to meagre analysis of the GDP level as there is a bevy of other intrinsic factors of influence.
Inflation rate. Inflation, in a simplified form, is the relation of supply and demand in monetary terms inside a certain state. The inflation indicator is appreciation of a certain consumer basket. The reasons for this appreciation, however, may vary greatly. Therefore it is more important for fundamental analysis to understand the underlying prerequisites of the ongoing, rather than the resulting total numbers. Furthermore, each individual country, depending on its current status, defines its own acceptable inflation rate that is subject to change if affected by unique factors. These factors are actually more indicative. Therefore, the factor decisive for traders is not the inflation rate itself but by how much it differs from the planned and projected rate. This is also called an inflation delta. In a classic market, a higher inflation rate would mean depreciation of the national currency. The opposite is known to have happened, but these were exceptions from the rule.
Benchmark interest rate (also known as the key interest rate). This is something of a rate defined by a country’s central bank (its chief regulator) and charged to all other commercial banks for “use” of its currency. The key interest defines all consequent rates, from mortgage to short-term loans. For a country’s chief regulator, the benchmark interest rate is the main instrument for controlling the financial environment. The higher the rate, the fewer the number of loans in the country, thus leading to a lower inflation rate. Notice that the inflation rate and the associated interest rate are the cornerstones of fundamental analysis.
Unemployment rate. This indicator is very important in fundamental analysis since it is most closely interlinked with a country’s GDP and affects it directly. It is pretty straightforward: able-bodied but unemployed population is a sizeable burden on the country’s budget that is determined from GDP indicators. However, unemployment indicators indirectly affect the analysis.
Trade balance. It is defined as a relation between a country’s exports and imports. A trade surplus means that the total value of exported goods is higher than that of imported goods, and the country sells more than it buys. This signifies a strong and independent national economy. A trade deficit, on the contrary, means more goods are bought than sold. Therefore, the country’s economy depends on economies of other countries, which is certainly not too good. It is also obvious that the more imports in a trade deficit, the larger the burden of the country’s budget, which in its turn, makes the economy as a whole more fragile.
Balance of payments. This is the household income level in relation to the expenditure level of a separate country as a whole. While balancing the year, the government may make a decision as to whether to increase or decrease its obligations to the partners, i.e. whether to increase the negative or positive balance.
Purchasing power parity. The PPP is rightfully considered one of the best fundamental indicators for the analysis, for it indicates general trends of economic development and facilitates establishment of the real value of the national currency. The PPP helps traders assess the value of the same goods in different countries. Besides, the difference in prices may serve as a basis for further analysis of the inflation rate and inflation risks.
Interest rate parity. This is considered to be the indicator most accessible for analysis of all existing fundamental indicators. It functions on the principle similar to that of the PPP, only based on the key interest rate of the country specified by its central bank. If the rates do not match, there is an imbalance in the yield of the financial instruments in possession of the chief regulator, e.g. of the government bonds.
Consumer price index. This quantifies the value of goods and services produced in a country without relation to the core PPI index. Essentially, it helps in objective assessment of the rate of growth or decline of prices in the country. Special attention is paid specifically to the deviations from expected numbers.
Consumer confidence index. Consumer confidence reflects the consumer sentiment. If the consumers have job security and are optimistic about the future, they are prone to spend more, which, in its turn, promotes economic growth. Optimism and pessimism are the main estimation indicators when determining prospects of further development of the country. Most often, strong consumer confidence signifies possible growth, which would influence formation of a bullish attitude in the market.
To summarize, it should be pointed out that all indicators of fundamental analysis must be considered jointly and in conjunction, and not separately. Besides, it is best to verify your analysis on a demo account before commencing real trading.
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