Economic factors define whether the prices of any asset class will rise or fall. Yet, many traders fail to pay attention to these economic drivers, and the effect is reflected in their haphazard approach to trading analysis and their lack of profit optimization.
Some traders rely on just technical analysis (analyzing chart patterns and price action repetitions) but they fail to understand that everything you see happening on the chart is controlled by economic drivers. When you make trading decisions based on economic data and events, you are engaging in fundamental analysis.
Let’s delve deeper into what fundamental analysis entails and how it affects the FOREX market.
What is Fundamental Analysis?
Fundamental analysis determines the value of a stock or other asset in the financial market. It involves an analysis of a company’s management, business model, financial ratios, financial statements, and other records. It talks about why the market is doing what it is doing relative to what is happening in the economy.
It also provides meaningful context about why the value of an asset is priced where it is. For one thing, understanding the value behind certain assets helps to make better trading decisions.
As a method of evaluating the intrinsic value of an asset, fundamental analyses examine the factors that could influence price in the future. This form of analysis is based on external events and influences, as well as financial statements and industry trends.
It is important to note that the intrinsic value or fair value of a stock does not change overnight. Such analysis helps you identify key attributes of the company and analyze its actual worth, taking into account macroeconomic and microeconomic factors.
To effectively carry out a fundamental analysis of the FOREX market, the following things are considered:
- Past data: This helps analyze how things have been in the past including the trends and patterns and the results it had in the past.
- Public information: This gives information about a company, a nation’s economy, business records, political activity, and financial data.
- Unknown public information: This is information that is not publicly known but is important in market analysis, such as leadership challenges and how crises arise and are handled in the company.
The main purpose for carrying out a fundamental analysis is to identify investment opportunities and be able to benefit from them on a small scale.
In carrying out fundamental analysis, you’ll come across two types: qualitative and quantitative fundamental analysis.
Qualitative Fundamental Analysis
This is a study that involves the brand value, management decisions, the financial performance of the company over a given period, consumer behavior, demand, company recognition in global markets, and other factors that affect the FOREX market. This helps to depict the social and economic position of the market.
Quantitative Fundamental Analysis
This is an analysis that is purely number-based, considers the company’s financial statements, and concludes the share price from the observations. This uses numerical data such as statistics, reports, and data.
It is based on the financial statements, quarterly performance, balance sheets, debt, etc, and involves analyzing numbers, ratios, and values to understand the price of the shares and the company’s overall financial health.
Steps to Carry Out a Fundamental Analysis
The following steps are important in carrying out a fundamental analysis of any FOREX asset.
- Understanding the company’s history, operations, business models, etc.
- Studying the economic indicators of the nation and understanding certain governmental policies.
- Studying the nation or company’s gross domestic product (GDP).
- Finding the company’s competitors and studying them.
- Understanding the industrial production and retail sales of the company.
- Studying the consumer price index (CPI).
These are just a few of the steps an analyst can take in carrying out a fundamental analysis of a stock or FOREX market asset.
How Fundamental Analysis Affects the FOREX Market
In FOREX markets and trades, news reports produce movements in the FOREX market, whether good or bad. Several economic indicators have an effect on the FOREX market, and some of the economic indicators are found in news reports that are released daily, weekly, monthly, quarterly, or annually.
Fundamental analysis involves research that has to do with the strength of an economy. If an economy is predicted to hold strong, it will appear as an attractive place for foreign investment because it is more likely to produce higher returns in the financial markets.
So in order to invest, investors will first have to convert their capital into the currency of the country in question. Buying more of that currency will push up the demand and force the currency to appreciate.
The major economic indicators that would influence the foreign market include interest rates, inflation, GDP, capital flow, and trade balance.
Wrapping Up on Fundamental Analysis
Understanding fundamental analysis is key to a balanced trading style and a balanced trading style is key to consistent profitability.
Knowing why it is important you understand which economic factors to look at and how they affect the prices of financial assets will help you make better trading and investment decisions.
As you work on beefing up your fundamental analysis skills, ensure you follow FOREX platforms like FXStreet.com, DailyFx.com, ForexFactory.com, and others as they offer news and analysis on economic data. Use them to keep yourself abreast so as not to be taken aback by economic events.
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