Those trading in the
foreign-exchange market (forex) rely on the same two basic forms of analysis that
are used in the stock market: fundamental analysis and technical analysis. The
uses of technical analysis in forex are much the same: price is assumed to
reflect all news, and the charts are the objects of analysis. But unlike
companies, countries have no balance sheets, so how can fundamental analysis be
conducted on a currency?
Since fundamental analysis
is about looking at the intrinsic value of an investment, its application in
forex entails looking at the economic conditions that affect the valuation of a
nation's currency. Here we look at some of the major fundamental factors that
play a role in the movement of a currency.
Economic Indicators
Economic indicators are
reports released by the government or a private organization that detail a
country's economic performance. Economic reports are the means by which a
country's economic health is directly measured, but do remember that a great
deal of factors and policies will affect a nation's economic performance.
These reports are released
at scheduled times, providing the market with an indication of whether a
nation's economy has improved or declined. The effects of these reports are
comparable to how earnings reports, SEC filings and other releases may affect
securities. In forex, as in the stock market, any deviation from the norm can
cause large price and volume movements.
You may recognize some of
these economic reports, such as the unemployment numbers, which are well
publicized. Others, like housing stats, receive little coverage. However, each
indicator serves a particular purpose, and can be useful. Here we outline four
major reports, some of which are comparable to particular fundamental
indicators used by equity investors:
The Gross Domestic Product
(GDP)
The GDP is considered the
broadest measure of a country's economy, and it represents the total market
value of all goods and services produced in a country during a given year.
Since the GDP figure itself is often considered a lagging indicator, most
traders focus on the two reports that are issued in the months before the final
GDP figures: the advance report and the preliminary report. Significant
revisions between these reports can cause considerable volatility. The GDP is
somewhat analogous to the gross profit margin of a publicly traded company in
that they are both measures of internal growth.
Retail Sales
The retail-sales report
measures the total receipts of all retail stores in a given country. This
measurement is derived from a diverse sample of retail stores throughout a
nation. The report is particularly useful because it is a timely indicator of
broad consumer spending patterns that is adjusted for seasonal variables. It
can be used to predict the performance of more important lagging indicators,
and to assess the immediate direction of an economy. Revisions to advanced
reports of retail sales can cause significant volatility. The retail sales
report can be compared to the sales activity of a publicly traded company.
Industrial Production
This report shows the
change in the production of factories, mines and utilities within a nation. It
also reports their 'capacity utilizations', the degree to which the capacity of
each of these factories is being used. It is ideal for a nation to see an
increase of production while being at its maximum or near maximum capacity
utilization.
Traders using this
indicator are usually concerned with utility production, which can be extremely
volatile since the utilities industry, and in turn the trading of and demand
for energy, is heavily affected by changes in weather. Significant revisions
between reports can be caused by weather changes, which in turn, can cause
volatility in the nation's currency.
Consumer Price Index (CPI)
The CPI is a measure of the
change in the prices of consumer goods across over 200 different categories.
This report, when compared to a nation's exports, can be used to see if a
country is making or losing money on its products and services. Be careful, however,
to monitor the exports - it is a focus that is popular with many traders
because the prices of exports often change relative to a currency's strength or
weakness.
Some of the other major
indicators include the purchasing managers index (PMI), producer price index
(PPI), durable goods report, employment cost index (ECI), and housing starts.
And don't forget the many privately issued reports, the most famous of which is
the Michigan Consumer Confidence Survey. All of these provide a valuable
resource to traders, if used properly.
So, How Are These Used?
Since economic indicators
gauge a country's economic state, changes in the conditions reported will
therefore directly affect the price and volume of a country's currency. It is
important to keep in mind, however, that the indicators discussed above are not
the only things that affect a currency's price. There are third-party reports,
technical factors, and many other things that also can drastically affect a
currency's valuation. Here are a few useful tips that may help you when
conducting fundamental analysis in the foreign exchange market:
Keep an economic calendar
on hand that lists the indicators and when they are due to be released. Also,
keep an eye on the future; often markets will move in anticipation of a certain
indicator or report due to be released at a later time.
Be informed about the
economic indicators that are capturing most of the market's attention at any
given time. Such indicators are catalysts for the largest price and volume
movements. For example, when the U.S. dollar is weak, inflation is often one of
the most watched indicators.
Know the market
expectations for the data, and then pay attention to whether or not the
expectations are met. That is far more important than the data itself.
Occasionally, there is a drastic difference between the expectations and actual
results and, if there is, be aware of the possible justifications for this
difference.
Don't react too quickly to
the news. Oftentimes, numbers are released and then revised, and things can
change quickly. Pay attention to these revisions, as they may be a useful tool
for seeing the trends and reacting more accurately to future reports.
Conclusion
There are many economic
indicators, and even more private reports that can be used to evaluate the
fundamentals of forex. It's important to take the time to not only look at the
numbers, but also understand what they mean and how they affect a nation's
economy. When properly used, these indicators can be an invaluable resource for
any currency trader.
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