Tom Hougaard discusses fundamental analysis and how it can be used in Forex trading. Learn which factors affect the currency markets and why it is important to keep ahead of economic developments.

Captions:

Introduction:
There are two kinds of analysis available to the trader and speculator, one of those is fundamental analysis – and in this chapter we will be looking at what fundamental analysis is and how to make the most of it for yourself.

Scene 1:
In order to establish both the state of a market and the direction of possible future movements, two types of analysis are undertaken:
1. Technical analysis
2. Fundamental analysis

Technical analysis is the study of past price behavior and the repetitiveness of the market participants. If you consider the market place as comprising millions of human beings, then you may come to the conclusion that their combined behavioral traits will be entirely random. In reality there is evidence that the markets are anything but random. We will look into this in much more detail later in the course.

Fundamental analysis is the study of economic factors and involves evaluating the potential affect which these may have on the markets. Now despite my degrees in economics and finance, I am a die-hard technician who will only consider one truth in the market, and that is the current price.

However, no one was ever served with having too narrow a perspective of the world, so we will start off by looking very briefly at what is being released and when, on the economic news front.

Scene 2: The Fundamentals
There is no doubt that the fundamentals are what shapes the economic landscape, and therefore the decision making process of the trader.

You can basically largely split down the fundamental story into 4 categories.
1. Economic factors
2. Financial factors
3. Political factors
4. Crisis factors

Economic factors differ from the other 3 in that there is a degree certainty about their release. The dates and time of the economic data are known well in advance, at least in most developed industrial nations. As a trader, I have a check sheet I go through every morning, in a similar manner to the pilot who goes through his or her pre-flight routine. One of these checks involves identifying economic news due to be released during the trading day. If you have ever been caught out by an economic news release which you did not know about, you will remember that event forever. Daily/weekly/monthly news releases are available on your trading platform.
The release of those numbers will often drive the market significantly in one direction as longer term traders adjust their financial models.

Scene 3: Economic Indicators
Economic indicators occur in a steady stream throughout the trading week. In the regulated market environments, they are always released at a specified time during the trading day.
Economic data is generally released on a monthly basis, although some numbers like GDP are released quarterly.
All economic indicators are released in pairs. The first number reflects the latest period, whilst the second number is the revised figure for the month prior to the latest period. For instance, in July, economic data is released for the month of June, the latest period. In addition, the release includes the revision of the same economic indicator figure for the month of May. The reason for the revision is that the department in charge of the collation of the economic statistics is in a better position to gather more information one month after the period.

This feature is important for traders. If the figure for an economic indicator is better than expected by 0.4 percent for the past month, but the previous month's number is revised lower by 0.4 percent, then traders are likely to ignore the overall release of that specific economic data.

Whilst economic indicators are released at specified times throughout the trading day, their release differs between countries. In the United States for example, economic data is generally released at 8:30 Eastern Timeand 10 am Eastern Time. It is important to remember that the most significant data for foreign exchange is released at 8:30 am Eastern Time. In order to allow time for last-minute adjustments, the United States currency futures markets open at 8:20 am Eastern Time.

Information on upcoming economic indicators is published in all leading newspapers, including the Wall Street Journal and the Financial Times. But you can also access it on our own website’s news services to receive the latest information in real-time.

Scene 4: The Role of Financial Factors
Financial factors are vital to fundamental analysis. Changes in a government's monetary or fiscal policies are bound to generate changes in the economy, and these will be reflected in the exchange rates.
Financial factors should be triggered only by economic factors. When governments focus on different aspects of the economy or have additional international responsibilities, financial factors may have priority over economic factors.

The realities of the marketplace revealed the underlying artificiality of this approach. Using the interest rates independently from the real economic environment translated into a very expensive strategy. As foreign exchange, by definition, consists of simultaneous transactions in two currencies, it follows that the market must focus on two respective interest rates as well. This is the interest rate differential; a basic factor in the markets.

Traders react when the interest rate differential changes, not simply when the interest rates themselves change. For example, if all the G-8 countries decided to simultaneously lower their interest rates by 0.5 percent, the move would be neutral for foreign exchange, because the interest rate differentials would also be neutral.

Scene 5: “Buy on the rumour, Sell on the News”
You have probably heard the old adage “buy on the rumour, sell on the news”. Well, foreign exchange markets often don’t move because of the fundamentals. Sometimes they are influenced by trader’s perception and expectations of the fundamentals.
Factors affecting the trading decision include the time lag between the rumour and the fact, the reasons behind the interest rate change, and the perceived importance of the change. The market generally prices in a discount rate change that was delayed. Since it is a “fait accompli”, it is neutral to the market. If the discount rate was changed for political rather than economic reasons, something which is a common practice in the European Monetary System, the markets are likely to go against the central banks, sticking to the real fundamentals rather than the political ones. This happened in both September 1992 and in the summer of 1993, when the European central banks lost unprecedented amounts of money trying to prop up their currencies, despite having high interest rates. The market perceived those interest rates as artificially high and aggressively sold short the respective currencies.
Finally, traders deal on the perceived importance of a change in the interest rate differential.

Scene 6: Political Events and Crises
Political events generally take place over a period of time, but political crises strike suddenly. They are almost always, by definition, unexpected. Currency traders have a knack for responding to crises. Speed is essential; shooting from the hip is the only fighting option. Reactions must be instantaneous. Without fast reflexes, traders can be left out in the cold. There is no time for analysis, and frequently there is only a split second, at best, to act.
Getting back to the market is difficult. There is no time to digest the news reports, and you can become caught up in the emotional turmoil of the market. It can be a scary, yet immensely profitable place to be.
As we go through these webinars you will be equipped with the necessary technical and mental tools required to cope with these events. So stick with me and let’s move on from the world of fundamentals to the world of technical trading.