Fundamental Analysis

It is commonly accepted that there are two major schools when formulating a trading strategy for any market, be it securities, futures, or currencies. These two disciplines are called fundamental analysis and technical analysis. The former is based on economic factors while the latter is concerned with price actions. Of course, the trader may opt to include elements of both disciplines while honing his or her personal trading strategy.

Supply and Demand

Fundamental analysis is a study of the economy and is based on the assumption that the supply and demand for currencies is a result of economic processes that can be observed in practice and that can be predicted. Fundamental analysis studies the relationship between the evolution of exchange rates and economic indicators, a relationship which it verifies and uses to make predictions.

For currencies, a fundamental trading strategy consists of strategic assessments in which a certain currency is traded based on virtually any criteria excluding the price action. These criteria include, but are not limited to, the economic condition of the country that the currency represents, monetary policy, and other elements that are fundamental to economies.

The focus of fundamental analysis lies in the economic, social, and political forces that drive supply and demand. There is no single set of beliefs that guides fundamental analysis, yet most fundamental analysts look at various macro factors.

Interest Rates

If there is an uncertainty in the market in terms of interest rates, then any developments regarding interest rates can have a direct effect on the currency markets. Generally, when a country raises its interest rates, the country's currency strengthens in relation to other currencies as assets are shifted away from it to gain a higher return elsewhere. Interest rates hikes, however, are usually not good news for stock markets. This is due to the fact that many investors withdraw money from a country's stock market when there is an increase in interest rates, causing the country's currency to weaken.

Knowing which effect prevails can be tricky, but usually there is an agreement among practitioners in the field as to what the interest rate move will do. The producer price index, the consumer price index, and the gross domestic product have proven to be the indicators with the biggest impact. The timing of interest rate moves is usually known in advance. It is generally known that these moves take place after regular meetings of the BOE (Bank of England), FED (U.S. Federal Reserve), ECB (European Central Bank), BO] (Bank of Japan), and other central banks.

Jason Stessler is an author for the website Forex Daily Signals:

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