Fundamental analysis of the market involves analyzing economic, social, and political forces that affect the supply and demand of an asset. Supply and demand determines the price, so this is a good indicator of whether it is going to rise or fall.
The basis of fundamental analysis is mainly on the political and economic changes as these can frequently affect currency prices. Thus, traders are most likely to gather information from news sources in order to determine unemployment forecasts, political ideologies, economic policies, inflation, and growth rates. Traders keep an eye on the figures and statements given in speeches by important politicians and economists, as well as announcements related to the United States economy and politics. Speeches from prominent people like the Chairman of the US Federal Reserve Bank often result in massive market movements.
In Forex trading, you perform a fundamental analysis of a country’s current economic condition. If it is good then the currency of that country should be strong. The lower the unemployment rate and the higher the retail sales, the better a country’s economy is. This, in turn, causes more investors and businesses to invest in that country and more demand for its currency. In recent times we have witnessed the AUD and the NZD dollar outperforming other currencies. This is due to the fact that both economies have remained resilient throughout the financial crises.
If we consider the USA, the dollar will gain strength because the economy is improving. As the economy gets better, the Federal Reserve Bank (USA’s central bank) will intervene by raising interest rates in an attempt to control growth and inflation. The higher the interest rates, the more attractive the dollar-denominated financial assets become. To invest in US assets, traders and investors have to buy some dollars first. As a result, the value of the dollar will increase.
To sum things up, fundamental analysis is a way of analysing a country’s currency using major economic indicators to determine how strong an economy is. The major economic indicators you should keep an eye on are: employment, retail sales, inflation, and interest rates. But just being aware of those indicators and expecting the market to react the way you want it to react in the short term is not fundamental analysis; it’s just wishful thinking. By focusing on a few isolated statistics, without placing them into a proper context and without understanding the workings of the economy as a whole, you are simply not getting the big picture.