The forex market is the market par excellence for fundamental analysis. Since currencies are the basic building blocks of all economic activity, all the developments in all the various sectors of an economy have implications for currency market trends. If the reader is only looking for a discussion of the various indicators and their application, he can simply skip this dialogue. I want to profit from currency trading. And I want to base my methodology on fundamental analysis.
How can I do this? You can do so by following fundamental news and central bank statistics. But, before that you must also have an understanding of the era you live in.
Each era has different dynamics driving its economic development. Financial institutions tighten their lending standards leading into and during the bust phase of the cycle, then relax them leading into and during the boom phase.
All else being equal, during the bust phase of the economic cycle, reserve currencies appreciate against the currencies of most other nations, and during the boom phase, reserve currencies tend to depreciate. This is because booms are financed by lending, and most lending is conducted through reserve currencies, due to the nature of the global financial structure.
So you say that I can profit by simply identifying the boom-bust cycle correctly, and arranging my currency portfolio to reflect that knowledge? Boom-bust cycles are very powerful, high-level events that force everything else to move in tandem with them. Once I identify the phase of the boom-bust cycle, how can I profit from news releases?
This picture can help you understand what goes on in the economy. By understanding the big picture, you can identify who is benefiting from it most, and then, as you place your trades in harmony with those who drive the main trends, you may turn great profits. There are two kinds of actors in any market: In some situations, where lending standards are lax and money flows in abundance, speculators can easily overcome those who are involved in genuine economic activity, and become the main drivers of the price trends.
You can simply follow the currency trends. If I use fundamental analysis simply to follow the trend, why not just follow the trend, while forgetting about fundamental analysis altogether? Because you will only follow the trend as long as the fundamental factors tolerate it. Through fundamental analysis, you will be able to avoid jumping on the train of speculation at the height of euphoria, and will be able to reverse your direction quickly when fundamental factors tell you that the benign economic environment has changed.
Remember, fundamental analysis studies the causes of economic events. Of course, even without detailed fundamental reasons, one can simply avoid a bubble once its price trajectory takes the form of a parabola. Then you must consider whether there are any new technological innovations, financial products, emerging nations, and so on, that can create the fuel for a period of healthy economic growth on a global scale. Then you must consider the political climate.
Is there a lot of political instability in those nations that drive global growth? Let me help you with a chart:. This is the first stage of fundamental analysis. Here you decide on the dynamism of the global economy. The health of the global economy can have a lot of bearing on such seemingly unrelated things as forex market volatility, carry trades, cross-border capital flows, and so on. It is also crucial when deciding whether one must be conservative or relatively optimistic in assessing high-frequency economic data such as durable goods orders, weekly jobless claims, etc.
So I should analyze the global economy at the highest level to decide on my forex strategy. Now, how will I decide on which currency I should buy and which I should sell? In deciding which currency to long or short, you will need to examine the fundamental health of the economy by considering the indicators which we will discuss shortly. Of course you can. Fundamental analysis is always right. The imbalances and abnormalities defined by it will always be corrected by policy action or market developments.
But it may not always be possible to guess how that correction will occur. Do not participate in parabolic price action, unless you have exceptionally good reasons for doing so. Anything can create a bubble, regardless of how convincing the rationalizations and the proposed causes are. Also remember that our descriptions are valid for a highly integrated, trade-intense, non-protectionist global economy.
In a non-free, protectionist environment, speculators are unlikely to find the capital they need for popping bubbles of giant scale, and that will grant trade flows a greater role in determining price trends.
Since the causes of price trends can sometimes be completely independent of the dictates of economic theory, fundamental analysis cannot present a complete picture by merely showing what is good or bad about an economy; if the market is in error over a period of years, successful analysis must also be able to show the powerful reasons for its errors. Choices that may eventually prove to be greatly detrimental to the well-being of the society at large may still be very lucrative for the individuals who make them.
In other words, the errors fuelled by bubbles are errors only in the sense that they cause great harm to the majority of people. Note that we use the term speculator to denote an actor who ignores economic realities, is emotional and obstinate about his practices. Speculative activity can even absorb non-financial actors like construction firms or exporters, and in fact anybody else.
Read a step by step guide to fundamental analysis. See which are the most important fundamental factors to analyze. Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you. What kind of dynamics?
What do you mean by understanding the era? And how can I do that? What will I gain by being aware of the phase of the cycle? How will I profit from understanding that? And how do I profit from that? Can you please show me how to construct the big picture? Let me help you with a chart: How can I use it for success in forex trading? Was this article helpful?More...