Whereas technical analysis involves poring over charts to identify patterns or trends, fundamental analysis involves poring over economic data reports and news headlines. (And nowadays….random tweets from a certain world leader.)
Fundamental analysis is a way of looking at the forex market by analyzing economic, social, and political forces that may affect currency prices.
If you think about it, this makes a whole lot of sense! Just like in your Economics 101 class, it is supply and demand that determines price, or in our case, the currency exchange rate.
Using supply and demand as an indicator of where price could be headed is easy. The hard part is analyzing all of the factors that affect supply and demand.
In other words, you have to look at different factors to determine whose economy is rockin’ like a Taylor Swift song, and whose economy sucks.
You have to understand the reasons why and how certain events like an increase in the unemployment rate affect a country’s economy and monetary policy which ultimately, affects the level of demand for its currency.
The idea behind this type of analysis is that if a country’s current or future economic outlook is good, its currency should strengthen.
The better shape a country’s economy is, the more foreign businesses and investors will invest in that country. This results in the need to purchase that country’s currency to obtain those assets.
In a nutshell, this is what fundamental analysis is:
For example, let’s say that the U.S. dollar has been gaining strength because the U.S. economy is improving.
As the economy gets better, raising interest rates may be needed to control growth and inflation.
Higher interest rates make dollar-denominated financial assets more attractive.
In order to get their hands on these lovely assets, traders and investors have to buy some greenbacks first. This increases demand for the currency.
As a result, the value of the U.S. dollar will likely increase against other currencies with lesser demand.
Later on in the course, you will learn which economic data points tend to drive currency prices, and why they do so.
You will know who the Fed Chairman is and how retail sales data reflects the economy. You’ll be spitting out global interest rates like song lyrics.
To be able to use fundamental analysis, it is essential to understand how economic, financial, and political news will impact currency exchange rates.
This requires a good understanding of macroeconomics and geopolitics.
No need to be intimidated by such fancy-sounding words though. For now, just know that fundamental analysis is a way of analyzing the potential moves of a currency through the strength or weakness of that country’s economic outlook. It’s going to be awesome, we promise!