Fundamental analysis is essentially a case of examining the political and economic events that may affect currency prices and these events are reflected in such things as a country's published economic policy, inflation, growth rates and rates of unemployment. So, by studying the historic effects of political and economic events on the value of a country's currency traders are able to predict the effect that present events will have upon currency prices today.
Like other markets the forex market is affected by both supply and demand which are in themselves influenced by general economic conditions. Above all, both supply and demand are affected by the strength of the economy (reflected in its foreign investments, gross domestic product and balance of trade) and also by interest rates.
For currency traders fundamental analysis involves looking at current economic conditions which can be seen through the various indicators such as producer price indexes, consumer price indexes, retail sales and durable goods orders which governments release periodically.
One central indicator for forex traders are interest rates because changes in interest rates can both strengthening and weakening currencies. For instance, while high interest rates might trigger stock market investors to sell in the belief that rising interest rates will also mean higher company borrowing costs hitting their share price, these same high interest rates could also strengthen the local currency so that it is an attractive currency to trade.
Another central set of indicators for the forex trader are international trade indicators. Whenever a country is showing a deficit on its balance of trade this is normally seen as an poor sign as money flowing out of the country to pay for foreign goods and services may well devalue the currency. For the forex trader however fundamental analysis may well show that market expectations mean that in certain circumstances a trade deficit is not at all unfavorable. For instance, some countries often operate with a trade deficit and so unless there is an unusual rise in this deficit then the currency will already reflect this fact.
In the United States there are currently some twenty-eight major economic indicators that forex traders look at to make their trading decisions because all of these indicators have a significant influence on the financial markets. At the same time countries around the world with frequently traded currencies also publish a similar set of indicators that once again have a major influence on their own markets. Foreign currency traders need therefore to familiarize themselves with these indicators and have at least a working understanding of exactly how they influence currencies.
Fundamental analysis is not easy and requires currency traders to deal with large amounts of information which often require some quite extensive analysis. Today however the advent of powerful personal computers and fast Internet access mean that currency traders can now not only quickly access the data that they need to perform fundamental analysis but also have access to some extremely powerful programs which will analyze that data for them at the click of a mouse.
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