Fundamental Analysis Forex is the study of Economic metrics which will have an effect on the present and future value of a economies currency.
The best way to summarise Fundamental Analysis in Forex is to use a phrase coined by James Carville in 1992: It’s The Economy, Stupid.
Jump straight to the Fundamental Analysis Indicators in Forex.
Fundamental Analysis in Forex is the analysis of the market based on the preceding, current and predicted economic, social and political factors that affect a market or currency. It is open to interpretation and is a constantly changing creature which is dependent on a specific set of Economic data.
Fundamental Analysis forms an essential part of the Defensive Trading Forex Strategy. It is founded in an understanding of the Economical factors that contribute to the changes in the prices of currencies.
Don’t miss our related post, What Is Inflation? [And Why You Should Care].
Defensive Trading Fundamental Analysis Indicators Forex
The market is a cruel mistress where Fundamental analysis concerned; it is possible for an asset to react in a way which is entirely inconsistent with what the fundamentals have indicated ought to happen.
It is also very common for an asset to react before the announcement of certain information has been released and the opinions and assumptions of politicians, economists and analysts to be ‘priced into the market’ days or even weeks in advance. In Fundamental Analysis, context it everything. It is the basis of forming market Sentiment.
It is important to remember that when we are talking about using Fundamental Analysis to trade a currency pair, we have to look at both sides of that pair.
Economic Calendar: To keep track of all economic data releases, and therefore to understand the fundamentals, you will use your economic calendar.
The best way to summarise Fundamental Analysis in Forex is to use a phrase coined by James Carville in 1992 when campaigning for the soon to be President Bill Clinton, when he succinctly stated; It’s the economy, stupid.
When it comes to trading, we look more closely at an economy at large by watching closely a variety of Economic Indicators from that economy. This makes up the biggest part of Fundamental Analysis.
Economic releases from an economy are, essentially, a health check of how well that economy is running. As with many things in life, how well something is running is usually directly correlated to demand for that particular thing.
For currency, the health check of the economy will affect the demand for a currency, demand made up mostly by investors. The behaviour of these investors usually seems to be quite fickle and it is not uncommon to see masses rush into, and out of, currencies which in turn affects the price. Therefore, economy affects price.
It isn’t always as simple as that, but it is generally true. This will become more apparent as we work through these Economic Indicators.
The specific information is micro-economic information which we will now explore in more detail.
Who Was Adam Smith?
Lorded as being the Father of Modern Economics, Adam Smith first published The Wealth of Nations in 1776.
Within, the renegade Scottish Economist and Philosopher documented a range of innovative ideas regarding Society and the Economy that emerged from the social shifts caused by the industrial revolution. Smith was a fundamental member of the group of Philosophers and Social Commentators credited as establishing the ‘Scottish Enlightenment’.
In his lifetime he introduced concepts such as the Division of Labours, Productivity and, Free Markets, all of which we take for granted as being elementary today.
Economic Fundamental Analysis Forex
Defensive Trading Forex Fundamental Indicator 1: Employment
What is Employment?
The Labour Market, also discussed as Employment, or rather Unemployment.
Employment is a key indicator of an economy’s health and Labour figures are released on a monthly basis, usually a week after the end of the month whose figures are being released.
There are two ways of analysing this information:
How are Employment figures calculated?
Firstly, there is a sample survey taken of the population which is then calculated as a weighted average to indicate the overall position of the population.
Secondly, there is the claimant count. This figure reflects just how many people have filed for unemployment benefits in that month, in other words, how many people have lost their jobs.
Why is Employment important to the Fundamental Analysis of Forex?
If you think about it, it becomes very clear why this is such a big one. Employee wages constitute household income and income equals spending power. The more people spending, the more business is generated in the economy, the more jobs are created, the more tax paid, and therefore the more money for all of the participants of that economy, including the State.
An expanding economy is a healthy one where inflation will remain steady and interest rates will gradually increase to keep it in check. Higher interest rates make an economy more attractive for foreign investors due to the better than average return on investment.
What is the Market Significance of Employment?
High
What is the effect of Employment figures on a currency?
A positive release of employment figures, namely a low or decreased unemployment figure, would be perceived as being good news for an economy and therefore a currency. Conversely, a bad release where unemployment figures have increased is perceived as being a warning sign, or an confirmation of troubled waters for an economy and therefore make it less desirable to outside investors, having a negative effect on the currency price.
Defensive Trading Forex Fundamental Indicator 2: Consumer Spending
What is Consumer Spending?
Broadly speaking, Retail Sales, another key indicator of an economy’s health.
How is Consumer Spending calculated?
Surveys of retailers are taken at random in the days following the end of the month.
It is important to note that this figure is an incomplete read on the total economy as it is not indicative of the amounts being spent in the service industries such as air travel, insurance and entertainment.
Secondly, it doesn’t indicate units purchased, it indicates amount paid, so it can give a misrepresented read, if retailers have increased or decreased prices to account for external factors, the consumer will pay that at the register.
Why is Consumer Spending important to Fundamental Analysis of Forex?
Consumer spending accounts for approximately 70% of the activity of an economy and retail figures account for approximately 1/3 of that.
If people are happy to spend then it is a good sign that the economy is stable on a grassroots level.
What is the market significance of Consumer Spending?
High
What is the effect of Consumer Spending on a currency?
This is one of the trickier indicators to get a handle on. From an external point of view, it would seem that higher retail sales would be a good indication that the consumer is in a good position and therefore would reflect well upon the economy.
However, it is important to remember that in this globalised world, many products are not locally sourced or manufactured and may be imported goods. This can result in a trade deficit whereby an economy is importing much more than they are exporting, which is actually bad news. Thus, always remember to check Trade Balance in addition to Consumer Spending.
Defensive Trading Forex Fundamental Indicator 3: Consumer Confidence
What is Consumer Confidence?
This information collates data about how consumers feel about their jobs, the economy and spending.
Results range between -100 to +100 so a positive reading indicates that consumers have an above average expectation, and conversely, a negative result will indicate that the expectation is negative.
How is Consumer Confidence calculated?
As with other indicators, the data is collated from a survey of a randomised sample of the population.
Why is Consumer Confidence important to Fundamental Analysis of Forex?
As outlined previously, the consumer’s spending is responsible for approximately 70% of economic activity, hence, a jittery and underconfident public is bad for spending, which is in turn bad for growth.
It has been highlighted over decades of data collection, that at the household level consumers are more adept at identifying an economy that is beginning to stall rather than one that is beginning to grow. This is thought to be due to the average household being more acutely aware of losing money than gaining it.
What is the market significance of Consumer Confidence?
Moderate, however, it can be a very significant precursor to a turning point in the economy.
What is the effect of Consumer Confidence on a currency?
A prolonged drop in Consumer spending slows the growth of an economy, which will likely have an effect on the decisions of the Central Bank who will have to consider lowering Interest Rates.
A lowered Interest Rate will in turn create less demand for the currency, as foreign investors will be better served allocating their capital to a higher yielding economy. This lack of demand will then decrease the price of the currency compared to any counterparts.
Defensive Trading Forex Fundamental Indicator 4: Consumer Price Index (CPI)
What is CPI?
Consumer price inflation is the speed at which the prices of goods and services bought by households rise or fall, and it is estimated by using price indices.
CPI is described as being like a very large shopping basket containing goods and services typically bought by households. The price index estimates changes to the total cost of this basket by calculating the average price changes of the items within the basket. It is the most used measure to calculate Price Inflation.
The measure is broken down into categories such as Food, Clothing, Transport, Housing and Leisure.
How is CPI calculated?
CPI is what is known as a weighted Price Index, a weight is attached to a category to reflect significance.
This is as households spend more on some goods and services than others, so we would expect, for example, a 10% increase in the price of petrol to have a much bigger impact on the basket than a similar rise in the price of sugar.
Why is CPI important to Fundamental Analysis of Forex?
CPI is an important indicator of how an economy is performing because it is the data upon which the Inflation Rate of an economy is derived, which has a direct relation to Interest Rates.
What is the market significance of CPI?
Very High
What is the effect of CPI on a currency?
Broadly speaking, CPI data measures inflation in an economy. When inflation gets too high in a country, the Central Bank may increase Interest Rates in order to ensure price stability.
This may cause the currency to rise in value as the additional interest received on the capital makes the currency more desirable to investors.
Defensive Trading Forex Fundamental Indicator 5: Housing
What is Housing?
This information gauges the residential property industry. Housing is actually a generalisation, the specific areas analysed are House Prices, New Home Sales, Exiting Home Sales, and Construction Spending.
How is Housing calculated?
Calculation is dependent on the specific kind of transaction that is being measured. For example, for constriction, a stat is counted when construction begins on the foundations of a residential building. For home sales, the figure is calculated after the transaction has completed.
Why is Housing important?
Historically, there have been exceptionally few instances of an economy running poorly during which the housing market has maintained its strength. In fact, Real Estate is credited with being one of the first sectors to shut down when an economy nears recession, and one of the first to bloom when the economy starts to improve. This is largely due to the housing markets close relationship to interest rates, however, indirectly.
When the interest rates are high, it generally discourages the demand for homes, however, as interest rates fall, which happens during times of economic weakness, interest in buying homes is reinvigorated due to loans being more affordable.
Housing: look the various Property booms that have taken place around the world in the wake of the latest Global Financial Crisis. In the decade that followed, almost all first world economies had interest rates that were historically low levels (often negative) for prolonged periods, making borrowing cheaper than ever in living memory.
Moreover, Construction, specifically, is dependent on the use of resources such as the employment of a workforce, steel, wood, electrical and gas resources, glass and concrete. It is easy to look at this industry and appreciate how the ‘multiplier effect’ will have a trickledown effect throughout the rest of the economy.
If people stop building or renovating houses, huge swaths of the economy will be negatively affected.
What is the market significance of Housing?
Moderate
What is the effect of Housing on a currency?
As with other economic indicators, strong housing reports are considered favourable for the direction of interest rates and therefore foreign demand for the currency.
Defensive Trading Forex Fundamental Indicator 6: Trade
What is Trade?
The Balance of Trade is the amount of goods an economy imports vs the amount of goods they export.
It is measured as a Trade Deficit (more imports than exports) or a Trade Surplus (more exports than imports).
How is Trade calculated?
Every month total exports such as agricultural or manufactured goods are compared to goods imported.
Each economy is slightly different in terms of goods produced such as mechanical, computing, vehicles, aeronautical, weapons, pharmaceuticals, mined resources, meat or farmed products.
Why is Trade important to Fundamental Analysis of Forex?
Trade contributes to Gross Domestic Product (GDP).
An economies dependence on goods imported makes it more susceptible to and sensitive to change that may affect the economy from whom they import those goods. That change may be natural or political.
What is the market significance of Trade?
Moderate
What is the effect of Trade on a currency?
If a country imports more than it exports, there is less demand for its currency, so in the case of currency, it loses value.
It is desirable for an economy to have a trade surplus to make it a more desirable and stable place in which to invest.
Defensive Trading Forex Fundamental Indicator 7: Purchase Managers Index (PMI)
What is PMI?
It tracks activity in manufacturing, retail and construction sectors and assess the level of new orders, however, there is also a non-manufacturing PMI.
PMI of more than 50 represents expansion of the manufacturing sector when compared to the previous month. A PMI reading under 50 represents a contraction, and a reading at 50 indicates no change.
How is PMI calculated?
PMI is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.
Why is PMI important to Fundamental Analysis of Forex?
There is a direct link between manufacturing output and employment.
What is the market significance of PMI?
High
What is the effect of PMI on a currency?
As this indicator is a measure of the overall health of an economy, a positive result is perceived as being good news for an economy and will therefore have a favourable effect on investor’s perceptions of its strength and future growth projections.
Defensive Trading Forex Fundamental Indicator 8: Interest Rates
What are Interest Rates?
An Interest rate is the cost of borrowing money, expresses as an annual interest rate.
How are Interest Rates calculated?
An interest rate is not so much calculated as set by the Central Bank of an economy, known as the ‘Base Rate’.
The decision to increase, decrease or keep the same the interest rate of an economy is based on the detailed analysis of all the economic indicators mentioned here in addition to others that would affect an economy specifically.
This will indicate the rate that banks and other lenders should both charge and pay to borrowers and depositors respectively.
Why are Interest Rates important to Fundamental Analysis of Forex?
Because the interest rate is a throttle for an economy, which can be used to both cool or to encourage growth by helping to regulate how cheap or expensive it is for consumers to borrow money to invest back into the economy.
What is the market significance of Interest Rates?
Very High, however, changes are usually priced in.
What is the effect of Interest Rates on a currency?
The higher the currencies interest rate the more favourable the return a foreign investor is receiving on money invested, therefore increasing demand for that currency, in turn driving up the price.
Defensive Trading Forex Fundamental Indicator 9: Gross Domestic Product (GDP)
What is GDP?
It is the measure of National Output. It is the total value of all goods and services made in that economy.
How is GDP calculated?
GDP = private consumption + gross investment + government investment + government spending + (exports – imports)
It can be given as Nominal GDP or Real GDP. Real GDP accounts for inflation.
Why is GDP important to Fundamental Analysis of Forex?
It is an overall barometer of the health of an economy and can used to analyse where an economy is heading.
It is used gauge if a nation’s economy is growing healthily or contracting in a recessionary business environment.
What is the market significance of GDP?
High
What is the effect of GDP on a currency?
When the GDP for a country comes out higher than the market is expecting, then that is usually positive news for the currency of that nation. Based on such good news, that currency will often appreciate relative to other currencies.
Defensive Trading Forex Fundamental Indicator 10: Central Banks and Monetary Policy
What is Monetary Policy?
The Central Banks are the US Federal Reserve (the Fed), The Bank of England, The European Central Bank (ECB), The Bank of Canada (BOC), The Bank of Japan (BOJ), the Reserve Bank of Australia (RBA), the Reserve Bank of New Zealand (RBNZ) etc.
Central banks set the interest rates of an economy and its monetary policy.
Monetary policy is a central Banks attempt to retain control and the predictability of growth of an economy, crating in turn stability.
When that doesn’t happen, it is the attempt to get the economy back on track and creating an environment of prosperity, but not too much.
How is Monetary Policy calculated?
The scariest thing about studying economics is realising that the people who discussing which economic theories to implement are actually making an educated guess on what the effects will be and, to a large degree, trying to figure out and understand why events took place in the past. So, it isn’t ‘calculated’ in the traditional sense of the word. It is more of a guestimate and is often experimental and reactionary to unforeseen circumstances.
Why is Monetary Policy important to Fundamental Analysis of Forex?
The faster and longer the economy grows, the higher the level of employment, which increases household income, which increases household expenditure whose demand then fuels companies to increase production, which requires further employees, which in turn further increases household income, which then increases demand for foreign products. Thus, it continues. In theory.
What is the market significance of Monetary Policy?
Very High
Dovish vs Hawkish: You will hear the terms Dovish and Hawkish when listening to reports of the language used by Central Bankers when discussing the economy, the monetary policy, its implementation and their forecasts. As the natures of the birds would indicate, Dovish refers to a non-committal, mild and cautious language being used. Conversely, Hawkish refers to more aggressive and assertive language.
What is the effect of Monetary Policy on a currency?
Everything a Central Bank does is in order to bring the Economy back on-line. This means that in times of trouble, we see actions that are aimed at stimulating an economy. Conversely, an economy that is running smoothly will be kept in check, preventing it from becoming ‘overheated’.
Final Word Fundamental Analysis Indicators For Defensive Trading Forex – Don’t Forget Consensus
A consensus is the agreed upon result for an economic data release. The top economists from leading financial institutions, such as Banks, make an estimate of what they believe the unemployment figure might be, for example.
After all the estimates have been collated and averaged, then the consensus figure is published.
This is used as a guide, however, if the real result differs enough from the consensus figure in either direction, this can have a very significant effect on the markets.
Results fall into one of three categories. As expected, better than expected or worse than expected.
Depending on the market conditions at the time, and the overall trader position on a currency, these can affect the markets in a variety of ways. There is definitely no hard and fast rule to data release.
For example, a positive jobs report might be released, making you think that the currency should strengthen, but it doesn’t. This doesn’t seem to make sense, until you realise that the positive jobs report came out during a holiday period which always sees higher rates of employment due to temporary seasonal workers being taken on.
In addition, this report comes out just after disappointing housing data had been released. You can see now why this ‘positive’ jobs information was not perceived as being a game changer by those who understand the market as a whole.
In addition to the above example, there is also another effect on the markets which can mute the effects of a seemingly important data release. This is known as the being “Priced in”. This occurs when trades have seen a long way out the change coming and aren’t phased when it actually happens.
For example, if the central bank of an economy raises their interest rates after a period of steady growth and constantly reliable inflation data, acceptable housing and employment data, then traders see it as being a ‘no brainer’. In addition to this, central bankers tend to be very transparent about their intentions and the conditions that they are waiting on before they take action to raise or lower an interest rate. To that end, traders can be caught off guard and this does happen, but it is not the norm.
Need More on Defensive Trading Forex?
For more on Defensive Trading, check out the Defensive Trading strategy, or, if you are new to trading and would like to follow a seasoned Defensive Trader, there are many available on social trading platforms. You can watch their every move in order to learn from how a successful trader sets up, enters and closes their trades.
For more on the analysis of Forex, please see our detailed post on the 4 best Technical Indicators for Defensive Trading.
As always, if you have any questions, we would love to hear from you in the comments box below. Happy trading!
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