It is often said that information is the key to successful Forex trading but, while accurate and up-to-date information is indeed essential for currency trading, it is the analysis of this information which is the real key. There are two main forms of analysis used in Forex trading - fundamental analysis and technical analysis - and here we examine just what is meant by fundamental analysis.
In its simplest form, fundamental analysis examines both political and economic conditions which might affect currency prices and Forex traders who use fundamental analysis rely on news reports for information about a whole range of things including economic policy, growth rates, inflation and rates of unemployment.
In essence, fundamental analysis provides an overview of currency movements and a broad picture of economic conditions that might well affect the value of a specific currency. With this picture in mind, Forex trader will then normally move on to use technical analysis to then plot entry and exit points into the market and to supplement the information gained from fundamental analysis.
The Forex market is much like any other market and is affected by the forces of supply and demand and these, in turn, are affected by economic conditions. Two of the most important economic factors affecting supply and demand are the strength of the economy and interest rates and the strength of the economy is affected by the gross domestic product (GDP), foreign investment and the economy's trade balance.
A whole variety of economic indicators are released by governments and other sources and are generally considered to be reliable measures of economic health which are followed by all sectors of the investment market. The majority of economic indicators are released monthly but some are issued more frequently, usually weekly.
Two of the most important fundamental indicators are international trade figures and interest rates, but other extremely useful indicators include the consumer price index (CPI), producer price index (PPI), purchasing manager's index (PMI), durable goods orders and retail sales.
Interest rates are an especially important indictor as they can have either a strengthening or weakening effect on a particular currency. High interest rates might, for example, attract foreign investment and strengthen the local currency, while stock market investors frequently react to increases in interest rates by selling in the belief that higher borrowing costs will have an adverse affect on many companies. Large-scale selling by stock investors can often result in a downturn in the stock market and the national economy.
International trade indicators are also extremely important to the Forex trader. A deficit on the trade balance, with imports exceeding exports, is usually seen as an unfavorable indicator as money flowing out of the country to purchase foreign goods may well have a devaluing effect on the currency. However, fundamental analysis will also indicate market expectations and these will often dictate whether or not a trade deficit is unfavorable. It may be the case, for example, that a county frequently operates with a trade deficit and that this has already been factored into the price of its currency. In general, trade deficits will only affect currency prices in cases where they are higher than the market would normally expect to see.
Each country will have its own set of economic indicators (there are currently some twenty-eight major indicators used in the United States) and these have a strong influence on financial markets. For this reason, Forex traders need to be aware of them and to study them carefully when preparing their trading strategies.
Fortunately, for those traders working on the Internet, many website today carry an abundance of up-to-date information, but it is up to individual Forex traders to take this information and apply the principles of fundamental analysis to it before making their trading decisions.
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