Fundamental Analysis or Causality of Events
The Foreign Exchange market is the most liquid financial market in the world. In its tri-annual survey (April 2013), the Bank for International Settlements found the forex market is now trading more than $5.3 trillion in daily turnover, more than any other financial market in the world!
Many experienced traders determine their positions based purely on technical analysis, but a balance of technical and fundamental analysis is key to having a solid trading strategy. It is of major importance to pay equal attention to both technical and fundamentals in such a large market. Admittedly technical analysis can assist with confirming trends and can help you qualify when to “enter” into a position. However, there are many reasons behind a particular currency pair’s volatility when key economic indicators/data is published.
In short, fundamental analysis provides an insight into how price action (movement) “should” or “may” react to a certain economic event. The release of economic data to the “market” often brings about a change in the “economic landscape” which, in turn, creates a reaction from both speculators and investors from all facets of the market (Buy & Sell Side).
Due to its size, and the wealth of available information (estimates, previous data etc), the FX markets tend to have “priced in” where a particular currency should be trading after the release of data. However, when data is released that are widely out of the expected “estimate” we often see high volatility which results in excessive movements in currency pairs. So, whilst it is important to know the markets estimate of a particular economic data release, it is equally as important to understand what the markets anticipation/prediction of that “number”.
So – understanding the impact of an “actual” number in relation to the “estimated” (or forecasted) number is the most important factor you need to consider when deciding to open a position. In general terms fundamental analysis tends to be more “vague” than technical analysis. Regardless of this knowing what are the key “drivers” of economic data releases can only but help in your trading strategy.
During any typical trading day there are a plethora of data releases. However, based on my trading experience the following 5 indicators/pieces of information/data (in no particular order) are “the ones to watch”:
• Geopolitical events/Acts of God: Because FX markets are “open” 24 hours a day, five days a week, they move fast when any news is released. FX rates react much more quickly to geopolitical events than the majority of other forms of investing. Simply put: currencies are more volatile.
Typically, these events include anything that couldn’t have been predicted such as war, civil unrest, weather situations or anything that causes uncertainty in an economy. Anything that is bad enough news on a geopolitical basis is going to have an impact on currencies.
These specific events in themselves do not move currencies; rather it is the underlying factors at play. The unrest brought on by “so called” Islamic State is a good example of this. While the events are stark enough, the “fear” in the market revolves around stability in an oil rich region. If oil production is threatened, then oil prices must rise, which push gasoline/petrol prices. Consumers then must spend more on gas/petrol, leaving them less to spend elsewhere, which can lead to stagnation in the economy.
• Commodity prices: Commodity prices affect currencies differently depending on the use of those commodities in each country. A lot of that depends on whether a country is a “net” importer or exporter of a particular commodity.
Crude oil prices are a good example of this. Canada is generally thought of as the currency (CAD) to benefit most from rising oil prices because it exports a considerable amount of oil. Therefore if the price of crude oil rises one would expect to see the value of the Canadian Dollar rise. Conversely, the United States often is hindered from rising oil prices because, (as studies have shown) as gas prices rise, consumers cut spending on other discretionary items to make up the difference. Therefore, in this example, as Crude Oil prices rise we would expect to see the US Dollar weaken.