One of the key drivers of market trends is fundamentals. Fundamental factors can be any economic or geopolitical reality that influences investor sentiment and currency valuations. Prices respond to a wide range of forces such as growth data, inflation levels, monetary policy, and political developments. All these drivers are what traders analyse and examine through fundamental analysis so they can trade confidently. Fundamental analysis complements technical analysis. Technical analysis focuses on price action. It uses indicators and technical charts.
First, fundamental analysis focuses on economic, political, and social conditions. It also examines reasons behind currency, stock, or commodity moves. For example, central bank interest rate decisions matter. Likewise, inflation, employment, and retail data are important. Therefore, traders watch these closely. As a result, they trade around them to explore market opportunities.
Fundamental analysis drivers
The main activity of fundamental analysis is looking at an economic calendar and identifying the economic indicators that may affect a trader’s asset.
These pieces of information reveal the health and direction of an economy, leading traders to make better choices. Among the most powerful of these indicators are GDP growth, inflation, employment statistics, and interest rates.
Gross Domestic Product (GDP) is the nation’s overall economic performance. A consistently growing GDP shows that a nation’s economy is healthy, hence making its currency stronger. Slowing growth or contraction, however, weakens it as investors are looking for better returns elsewhere.
Inflation is important too. Moderate inflation tends to be a sign of economic health, but if prices are rising too fast, central banks will intervene with rate increases which tends to strengthen a currency. Traders who track inflation reports can make those transitions before they happen.
Hiring numbers, such as the U.S. Non-Farm Payrolls report, usually elicit sudden market reactions. A robust rise in employment suggests a strong economy and may trigger a central bank to pursue a tighter monetary policy, while weak data may result in interest rate cuts or stimulus packages.
Interest rates are perhaps the most powerful of all. Central banks like the Federal Reserve, ECB, or BoE set interest rates. They do this to control inflation and stimulate growth. Higher rates attract foreign capital. Consequently, this makes the currency stronger. Lower rates tend to depreciate a currency.
Traders examine data along with news events, such as elections, pandemics, wars, or trade agreements. By doing this, they gain a bird’s-eye view of market momentum. This perspective goes beyond what technical charts alone can provide.
Why it is important for traders to know fundamental analysis?
While short-term price movements can seemingly be random, long-term tendencies are nearly always based on fundamentals.
For example, when the Fed raises interest rates, the greenback goes up and when the ECB cuts rates or provides gloomy commentary, the euro weakens. These are almost always true, and traders who watch the news start recognising such patterns and repeated reactions that give them a better understanding of the market and make them better prepared.
On the other hand, traders who ignore these macroeconomic realities and instead choose to look solely at the charts may be perplexed by price moves that are driven by such factors. Both types of analyses are, nonetheless, important and valuable to traders and when used in combination, empower traders with more spherical and balanced knowledge.
Economic news and market sentiment
The foreign exchange market lives on information. Traders around the globe react to news announcements — sometimes in seconds — every day. Economic calendars are full of releases from central bank meetings to inflation levels to consumer sentiment surveys.
Take the U.S. Non-Farm Payrolls report, for example. Published on the first Friday of each month, it paints a picture of job market conditions in the global economy’s biggest player. A higher-than-expected number tends to spark dollar appreciation because investors expect the monetary authority to impose tighter policy. A low number tends to crash the dollar.
Similarly, European Central Bank or Federal Reserve moves can reshape world market sentiment in a matter of minutes. When a central bank becomes « hawkish » and signals rates to rise further, the currency tends to appreciate, but it weakens when it indicates a path to looser economic policy.
Political and other global events such as Trump’s trade policies or the war in Ukraine, can also cause massive market fluctuations as investors become worried about the economy and potential disruptions.
Traders who are well-informed and view these events through the prism of fundamental analysis are better placed to respond fast and make informed decisions as opposed to emotional ones.
Trading long-term and seeing the bigger picture
Whereas technical analysis concentrates on short-term trends, fundamental analysis tends to expose the larger picture. It brings into focus the way economic cycles play out over months or years, allowing the trader to position himself/herself strategically.
For example, if an economy is coming out of a recession, initial signs such as rising employment levels and consumer confidence can be a signal of a potential bullish cycle in its currency.
Similarly, recurring inflation or debt crises may lead to a currency depreciation. Traders can watch fiscal policy and government debt levels to determine whether an economy’s fundamentals support a currency value or devalue it.
This long-term perspective is invaluable to swing traders and investors who prefer to hold positions for weeks and months rather than minutes and hours. It provides a sense of direction in a market that often seems random.
Fundamental analysis and trading strategies
Implementing fundamental analysis in your trading strategy does not mean you suddenly have to become an economist. It is simply a question of understanding which data points are most significant to the investments you trade and how to interpret them.
As a forex trader, this means keeping a close eye on central bank statements, inflation figures, and job numbers. Monitoring reputable financial news outlets, following economic calendars, and reading market analysis can provide insight daily about potential drivers.
It is also helpful to establish an individual framework to analyse news. Ask questions such as: Is this data strengthening or weakening the currency outlook? How might this influence central bank policy?
Market timing
Timing is always an issue even for the most experienced traders. Even when fundamentals point to a currency’s strength, markets take time to adjust to those facts. That’s why there are traders who apply technical analysis in addition to fundamentals to adjust their entries and exits.
For instance, a trader can identify a bullish long-term expectation for the greenback because interest rates are rising but will wait for the technical pullback or breakout in the USD/JPY chart before making the trade. Such a mix of macro knowledge and proper timing minimises risk and maximises potential profitability.
Every trader’s indispensable skill
Fundamental analysis is traditionally considered to be the domain of analysts and economists, but in fact, it’s an indispensable skill for every trader. By monitoring economic fundamentals that impact prices, traders have a greater sense of why markets are acting the way they are and where they might be headed next.
Disclaimer: This information is not considered investment advice or an investment recommendation, but instead a marketing communication.
