Defining the Basics: Market Analysis Continued
In my last post I discussed the first of three crucial types of market analysis – technical. To those quick thinkers out there, you’ve probably guessed that this post will, quite logically, be about the second – fundamental anaylsis! So, let’s get started on tackling this one.
Simply put, fundamental analysis is the process of understanding the market by examining economic, social and political forces that may affect an assets supply or demand. This one, you’re probably thinking, makes complete sense; supply and demand are the major determiners of the price of any product and commodity out there, or in our case, the currency exchange rate. However, there is a catch. Whilst it’s fairly straightforward to use supply and demand as an indicator of price changes, analysing all of the factors that affect them can become rather difficult (but don’t worry, it won’t be difficult for long).
Basically, in order to determine which currencies to avoid and which to buy, you need to take a look at the different factors that might affect their popularity – and there can be quite a few. Furthermore, it’s important to understand the reasons why and how particular events and occurrences can have an affect on an economy and demand for that currency. Fundamental analysis is based on the theory that if a country’s current and/or future economic outlook is positive, then logically speaking, the currency should become stronger. Therefore, the better shape an economy is in, the more foreign businesses and investors will financially support it – mainly by buying into the currency of that economy.
For example, let’s say that the UK unemployment rate drops significantly. This is one strong sign that the economy is improving. As it gets better, interest rates are often raised in order to control growth and inflation. In turn, these higher interest rates make GDP-designated financial assets much more attractive, which can only be obtained by purchasing the currency first. This results in the value of GDP increasing and ta-da! We’ve just done some fundamental analysis. It wasn’t that painful was it? The great news is that fundamental analysis actually gets rather easy once you know what you’re looking for, and as with many things in life, experience will only improve your adeptness and speed at this.
Stay tuned for the next post, which will address the final third of the three-legged stool of analysis: sentiment.