11.4 How is Fundamental Analysis Applied to Fx?

Additional Reading About is your Profit a Good Profit

Applying Fundamentals to Trading - Text Version

In this course’s previous lessons, we have explained what fundamental analysis is, what fundamentals are, which economic data releases are important, and the role central banks play in shaping the economic fundamentals of a currency.

In this final lesson, we will show you how to bring all this knowledge together and apply it to make your Forex trading more profitable.

Our first step is to decide which currencies we want to make a fundamental analysis of. You can get by fine as a Forex trader just by watching a handful of the most important global currencies, such as the U.S. Dollar, the Euro, and the Japanese Yen. You really don’t need to spread yourself too thinly!

Our second step is to analyse the recent data from those countries, over the past few months. We also need to see the market consensus forecasts for each of them. You can get this information by scrolling back in time through an economic calendar, available on the websites of many Forex brokers and Forex-related website. Once you have the data, compare the trends in GDP, inflation, and interest rates – are they going up, or down? Were they mostly exceeding forecasts, or undershooting? Go read about the central bank statements over the same period. Are they seen as more hawkish or more dovish? Were there any surprises?

Once you have done this, you can make a table showing the data, and you should be able to decide whether each currency has strong fundamentals, weak fundamentals, or a mixture. You now know which currencies you want to buy, which you want to sell, and which you want to avoid. Well done! You have completed your fundamental analysis.

A very important secret of fundamental analysis is this – whether fundamental data surprises the market is often more important than the data itself. For example, let’s imagine that our data for the Eurozone shows rising GDP, rising inflation, and rising interest rates over the past few months. These are obviously bullish fundamentals. But let’s check what the market consensus was before all those items were released. If the market was expecting all these numbers to be strong, then the effect on the currency might not be so bullish, as the information has already been “priced in” by the market. However, if any of the numbers came in much higher than the market was expecting, then the market consensus has changed to become more bullish, and this is usually reflected by a stronger rise in the value of the currency.

The last question is – how to apply it.

If you were investing, you might just buy and sell the currencies and sit tight waiting for a profit to arrive some time in the future. But we’re not investing here, we are trading, so most the time we are looking to take profits after a few hours, or maybe a few days at most. Forex brokers charge you every night you leave a position open, which is one of the reasons why timing is so important – and timing trades correctly requires that you apply some element of technical analysis. You can best apply your fundamental analysis as a trade filter.

Let’s suppose that your fundamental analysis tells you that the U.S. Dollar should be strong, and the Euro should be weak. This means you are looking to sell EUR/USD. You can take any good technical trading strategy and apply it to the EUR/USD currency pair, but only take the short trades where you sell EUR/USD. So, if the strategy tells you to buy EUR/USD, you ignore it and don’t take the trade. If your fundamental analysis is any good, then using it as a trade filer should improve your profitability.

Another way you can apply your fundamental analysis is by using it to analyse trends. For example, if you are fundamentally bearish on the EUR/USD, but it has been going up over the last few months, your analysis is either wrong or you are too early, so stand aside. In contrast, if it has been going down over the last few months, the price action is matching your fundamental analysis, and both fundamentals and technical are in sync, telling you to look for new short trades here.

Well, that covers how we can apply fundamental analysis to improve our Forex trading. You can make a profit trading only with technical analysis, but the very best and most rewarding trades often come when fundamental analysis is telling you the same thing at the same time.