Traders in the foreign exchange market (forex) depend on the same two types of analysis employed in the stock market: fundamental analysis and technical analysis. The applications of technical analysis in forex are similar: the price is supposed to reflect all news, and the charts are the objects of study. However, unlike corporations, governments do not have balance sheets, so how can fundamental analysis be performed on a currency?
Because fundamental analysis focuses on the inherent worth of an investment, its application in forex requires examining the economic variables that influence the value of a country’s currency. Here we look at some of the important basic elements that influence the movement of a currency.
Economic indicators are government or private-sector reports that describe a country’s economic performance. Economic reports are a direct indication of a country’s economic health, but keep in mind that numerous variables and policies influence a country’s economic performance.
These reports are produced on a regular basis and provide the market with information on whether a country’s economy has improved or decreased. The consequences of these reports are similar to how earnings reports, SEC filings, and other releases may influence equities. Any variation from the usual in forex, as in the stock market, may produce big price and volume changes.
Some of these economic information, such as the unemployment figures, may be familiar to you. Others, such as housing statistics, get less attention. Each signal, however, has a certain role and may be valuable.
Gross Domestic Product (GDP)
GDP is the broadest measure of a country’s economy, representing the total market value of all products and services produced in a given year. Because the GDP number is sometimes seen as a lagging indicator, most traders concentrate on the two reports produced in the months before the final GDP figures: the advance report and the preliminary report. Significant adjustments between these reports may lead to significant volatility. The GDP is similar to a publicly listed company’s gross profit margin in that both are indicators of internal growth.
The retail-sales report totals the revenues from all retail outlets in a specific nation. This metric is obtained from a broad sample of retail establishments around the country. The report is especially valuable as a timely estimate of broad consumer spending trends that have been adjusted for seasonal factors. It may be used to forecast the performance of more significant lagging indicators and to analyze an economy’s current direction. Revisions to advanced retail sales data may generate substantial volatility. The retail sales report may be likened to a publicly listed company’s sales activities.
This report depicts a shift in a country’s output of industries, mines, and utilities. It also provides their “capacity utilization,” which is the percentage of each factory’s capacity that is being utilised. It is desirable for a country to have a rise in output while operating at or near full capacity.
Traders that use this indicator are often concerned with utility production, which may be quite volatile since the utility business, and hence the trade and need for energy, is greatly influenced by weather fluctuations. Weather variations may generate significant adjustments between reports, causing volatility in the country’s currency.
Consumer Price Index (CPI)
The CPI tracks price changes in over 200 distinct consumer goods categories. When contrasted to a country’s exports, this report may be used to determine if a country is earning or losing money on its goods and services. However, keep an eye on exports – this is a favorite topic for many traders since export prices often fluctuate in relation to the strength or weakness of a currency.
The purchasing managers index (PMI), producer pricing index (PPI), durable goods report, employment cost index (ECI), and housing starts are all important indicators. Not to mention the several privately published studies, the most well-known of which is the Michigan Consumer Confidence Survey. If utilized correctly, all of them may be a significant resource for traders.
Using Economic Indicators
Because economic indicators measure a country’s economic health, changes in the circumstances reported have a direct impact on the price and volume of a country’s currency. It is crucial to remember, however, that the indications outlined above are not the only factors that influence the price of a currency. Third-party reports, technical considerations, and a variety of other variables may all have a significant impact on the value of a currency. When doing fundamental research in the forex market, keep the following in mind:
- Keep an economic calendar on hand that identifies the indicators and their publication dates. Also, keep an eye on the future; markets sometimes react in anticipation of a certain indication or report that will be revealed at a later date.
- Keep up to date on the economic indicators that are catching the majority of the market’s attention at any given moment. Such signs act as triggers for the most significant price and volume fluctuations. For example, when the US currency is weak, one of the most closely followed indicators is inflation.
- Understand the market expectations for the data, and then monitor if those expectations are satisfied. This is significantly more crucial than the data itself. Occasionally, there is a significant disparity between expectations and actual performance. If this is the case, be aware of the various explanations for the disparity.
- Don’t be too eager to respond to the news. Numbers are often provided and then changed, and things may change rapidly. Pay attention to these adjustments since they may be a helpful tool for identifying patterns and responding more effectively to future reports.
The Bottom Line
There are several economic indicators, as well as numerous private reports, that may be utilized to assess forex fundamentals. It is critical to spend time not just looking at figures but also understanding what they imply and how they effect a country’s economy. When applied correctly, these indicators may be a tremendous asset to any forex trader.
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