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FX SCHOOL (5) : Fundamental Analysis & Economic Indicators

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Old 11-08-2009, 06:57
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Default FX SCHOOL (5) : Fundamental Analysis & Economic Indicators

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In Forex, the term “Fundamental analysis” refers to observing the latest global economic news / financial situation and knowing how this might affect the direction of the currency markets, then applying this knowledge into actually buying or selling a particular currency pair, if the right conditions have been met. Obviously each country has their own important news, so if you’re a fundamentals forex trader, you’ll need to be aware and up to speed with the different information/details/data coming out of certain countries. Many news announcements have fixed dates and times of when they’re going to be released. Of course there are also spontaneous announcements which affect the markets, such as a bank going bust, or a merging between two major corporations, etc… For the fixed news announcements, you can see what date and time each one will be released (on the internet).

The above figure is an example of a timetable of news releases for the first week of the month of March, 2009.

As you can see, each country has their own news, specific to them. Some of these are not really important, others are. The more important each news release is, the more of an effect it will have on the market. In this section, we are going to take a look at some of the most important news releases from a handful of countries.


USA – Non-Farm Payroll (Employment Change)

Let’s take the USA’s job market as an example, and how this affects the US Dollar. The Non-Farm Payroll tell us the change in the number of employed people in the United States during the previous month, excluding the farming industry (hence the non-farm prefix). This vital bit of news is released once a month, (usually on the first Friday of each month.) Even though nobody knows what figure that change will be, that doesn’t prevent industry experts making an educated guess as to what the figure will turn out to be. This educated guess is known as the “expected figure” or “forecasted figure”.

If the actual figure released is greater than what’s expected, then it means that there are less people out of work, which can only be good news for the country as a whole. Thus, if the country is doing better than expected in terms of (un)employment, this in turn means it’s good for the countries currency, and will invest into the US Dollar. Hence the US Dollar will gain strength. If the actual figure that’s released is less than the forecasted figure, then this is bad news, and the US Dollar will weaken.

And in fact, if you observe for example, the USD/JPY chart during the news announcement, you’ll see immediate reaction to this news release, and price will either go up or down considerably, depending on the actual figure in relation to the expected figure. To demonstrate what I mean, here is what happened in October 2008.

The above timetable shows which important news announcements are coming out of which countries on Friday the 3rd of October, 2008. So as we can see, we have the Non-Farm Employment Change coming out of the USA (the USD simply means that this news affects the US Dollar) at 8.30am Eastern Time.

So now, let’s take a look at the figures. The actual and forecast. The forecasted figure is on the right hand column, and as soon as the actual figure is released, it’s displayed on the 2nd column from the right.

So, as you can see, the figure was forecast to be -100K, but unfortunately it turned out to be -159K. This is bad news for the economy, because it means there are more people out of work than expected, hence the US Dollar would decrease in strength.

And that is exactly what happened.

If you look at the chart below, you’ll see the market was heading up before the announcement, but then as soon as the actual NFP Employment figure was released (point 1), look what happened. There was an immediate downturn and the US Dollar became weaker.

Before the announcement, the USD/JPY was trading at approximately 106.10, but after the NFP figure was released, within a matter of minutes, it was already down below 105.00. (Remember, currencies are ALWAYS traded as pairs, which is why we’re looking at the USD/JPY. We can also look at GBP/USD, EUR/USD, USD/CHF and others, as long as the USD is one of the currencies in the pairing, because the USA’s NFP release affects the US Dollar)

This kind of rapid movement often occurs with many of the major news releases, and the NFP is a very good economic indicator of the employment rate and overall strength of the labor market. It represents all business employees (excluding general government employees), private household employees, and employees of nonprofit organizations, accounting for about 80% of the workers who contribute to GDP.

In fact, the Non Farm Payroll is the most important economic piece of data that comes out of the USA every single month.


UK – Retail Sales

In short, the Retail Sales news release reflects the change in the total value of inflation-adjusted sales at the retail level. It’s a monthly measurement of all goods sold by retailers based on a sampling of retail stores of different types and sizes. Indeed, it's the primary gauge of consumer spending, which accounts for a majority of overall economic activity; which is why it’s often taken as an indicator of consumer confidence.

If we look at the timetable, we’ll see that the Retail Sales announcement for the GBP (£ - Great British Pound), was due to be released on November 20th 2008, at 5.30am Eastern Time. Although it might seem early (or late depending on how you look at it), remember, Forex is a 24 hour market, and it’s actually 9.30am in the UK. As you can see, the forecast was -0.9, but the actual was 0.1, better than expected, so this is good news for the United Kingdom. Let’s see how this news announcement affected the Great British Pound, i.e. the UK market.

We have a GBP/USD chart below, after the actual figure was released, the Pound became stronger, and increased by a decent number of pips. (Remember, currencies are ALWAYS traded as pairs. We can also look at GBP/JPY, GBP/CAD, EUR/GBP, and others, as long as the GBP is one of the currencies in the pairing, because the UK Retail Sales affects the UK Pound).

You’ll notice that after the market went up by around 80 pips, it then decided to come back down by around 50 pips, only to bounce back up again. This coming back down and bouncing up again is known as a retracement.

How does a trader profit from this type of movement in the market? Well, although it is possible, it’s actually not as easy as it looks. Firstly, not all movement are as clean as this, there can be a lot of choppiness. Secondly, you have to be really quick to enter the market if you want to capitalize on these kinds of moves. However, these types of trades are for advanced traders, and it’s safer to let things settle down a little, analyse the market, and then make a decision on whether you want to enter at all. A major news release can affect the market for hours and days; you don’t necessarily need to enter immediately after the news release.


Further Fundamentals

This is just a glimpse of the fundamentals world in FX. There are many other reports, known and unknown, that affect a country’s currency. The forex fundamentals trader highlights and measures factors that determine the essential value of any given country’s currency strength, such as the general economic and political environment, and including any that affect supply and demand.

Fundamental analysis entails the examination of macroeconomic indicators, asset markets and political considerations when evaluating a nation's currency in terms of another. Macroeconomic indicators include figures such as growth rates; as measured by Gross Domestic Product (GDP), interest rates, inflation, unemployment (such as the NFP we looked at above), money supply, foreign exchange reserves and productivity. Asset markets comprise stocks, bonds and real estate. Political considerations impact the level of confidence in a nation's government, the climate of stability and level of certainty.

In simple terms, fundamental analysis focuses on financial and economic theories, as well as political developments to determine why, when and where prices will move in the market. One clear point of distinction between fundamental and technical analysis is that fundamental analysis studies the causes of market movements, while technical analysis studies the effects of market movements.

All of the news reports, economic data and political events that come out about a country are used by investors to gain an idea of market sentiment. This of course changes over time due to many factors, including economic growth and financial strength. Fundamental traders look at all of this information to evaluate a country's currency.

Traders generally fall into two camps. Technical and fundamental. Naturally, technical traders think they have an edge over their fundamental counterparts, and vice versa. Which methods you choose are entirely your choice, they’re both very profitable methods of trading. Having said that, they’re not mutually exclusive, and many traders do apply both. In fact, applying both is definitely the wise thing to do.

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