An Intern Learns - More about Fundamental Analysis
News and economic events have always had a profound impact of how we live our individual lives as well as how people all over the world change and adapt as a collective. The world of foreign exchange is no different and in fact is one of the most susceptible areas to news events. In the last few blogs I’ve expanded on the more technical approaches to trading. However it’s not enough to simply have a technical understanding of the charts – a fundamental approach is also very useful. This approach is concerned with looking at the broader news picture, such as political, social and economic outlooks, and considering how this can impact the price movements of the various currencies.
Just to give you a taster of how potent a news snippet can be, take a look at the screen grab below of the USD/JPY. On Friday, 05 October, at 13:30 the stats for the US non-farm payroll (NFP) were released. After a little research on some forex websites, I saw that the actual stat of 142K matched the forecast of the same value. As described in the grey block in the screen grab, this is still a high figure for the NFP and normally means for a bullish trend for that currency pair. You can see that as this news item was released, showing a more favourable economic situation in America, the USD’s value strengthened significantly against the JPY. A more favourable economic environment means that people will more likely want to invest in the American economy by purchasing its currency; a key driver for demand for the currency. If you had been able to catch this you would have been able to score some great pips! As I’d like to explain further, it’s all really about supply and demand.
The fundamental approach to trading rides on the basic premise of supply and demand. A fundamental approach is essentially the study of the various factors that affect supply and demand. If there is an excess supply of the currency, i.e. the demand is low then it’s value will also be low. Conversely, if there is high demand and a limited supply of that currency, its worth will increase. This applies to all commodities. For example, as the years go on and the oil reserves slowly deplete, the high demand for it is unlikely to change but the supply will dwindle. So prices will continue to rise, as those in control of the reserves are able to charge whatever they like, and whatever the market will bear. People will still need the commodity, and as they have few options, they will be forced to pay market prices.
In light of this, one of the most important things a trader needs to know is where to source useful and timely information on key news and economic events which are likely to have the most profound effects on the markets and therefore on currency price movements.
Luckily if you trade with MahiFX you won’t have to travel far to receive key news events. MahiFX has a news and calendar tab under the ‘Trade’ section. Similarly the news events are plotted on the charts when they come out, and can be seen as little grey triangles along the base line of the charts. These can be seen when you are in ‘Analysis’ mode. These are great as you can see which news events have a strong impact on the price movement.
The one that I find most useful is the forex calendar. This shows all the important forex dates and what time the event occurs. By using this function, you can diarise the dates and times that are most likely to affect your trades. The titles that are highlighted in red are new events that have been added since you last logged in. On the far right had side are numbers indicative of the importance of the event; 1 being most important and 3 being of lesser importance. At first glance these events can seem a bit random but you can quickly learn how to pick out the significant ones. Remember, we are looking for events that will tell us more about a particular currency, specifically whether the event will suggest a bullish (strengthening) or bearish (weakening) trend. These news events are categorised as being important if the result is likely to have a strong impact on a currency; I’m going to discuss the major ones here.
Pay attention when any president or leader of a major bank makes a speech. These important figures have a strong influence on monetary policies and their decisions can have major implications for economies. A main one in Europe is the European Central Bank (ECB). Non Farm Payrolls (NFP) are equally important. “Non-Farm” does sound like an odd term but this actually refers to all the employment excluding agriculture. As agriculture varies depending on the season this has been removed. The NFP to look out for is the US one and this is released on the first Friday of every month. This will indicate the difference in employment, e.g. in the case of the 05 October example I referred to above, this value was 142K, meaning there was 142K more people working since the last NFP release. Any manufacturing stats such as a manufacturing Purchasing Managers Index (PMI) are important as this is information garnered from a large pool of purchasing managers and gives a very good indication of how healthy the manufacturing sector is. Steady manufacturing is obviously good for an economy. Similarly a construction PMI is also important, showing how much new construction there is. More construction means more jobs, more money being spent and new infrastructure, which are all indicative of a healthy economy.
I know there’s a lot to take in! A fundamental analysis takes a lot of research and learning but it helps give you a truly holistic view of a country’s economy and it’s very important to have this knowledge when trading. In the next blog I’m going to explore the events above a bit more, specifically how to interpret the data you find. I will also explore some broader concepts such as inflation and interest rates and how these effect price movement on the charts.
The basic concept behind this all is that you as a trader need to keep an eye on these events, as these often have a direct link to what is happening is the charts. The trick is to learn which event to will have a big impact on the charts and then to be able to decipher the results.
Think of it this way; a commodity such as a piece of fruit has a very low purchase value. One of the reasons for this is because there are so many of them, everyone can afford to buy them at a low price - an orange should normally cost you less than a Pound. Now imagine some orange killing disease wiped out almost all the oranges in the world. Only a hundred or so oranges were left in the entire world; only the richest would have the luxury of being able to buy an orange because the demand for oranges stayed as high as always but the supply dropped right down.