How to Conduct Fundamental Analysis in Forex?

New forex traders are faced with the challenge of deciding which trading strategy to use. Some say you only need technical analysis, but that's just not true. You have to know that fundamental analysis is just as important as technical analysis to becoming a profitable trader.

In this article, we will focus on fundamental analysis and tell you how to make excellent investing decisions by using fundamental analysis.

What Is Fundamental Analysis?

As one of two major methods of market analysis, fundamental analysis is based on taking into account the economic fundamentals of a given asset, sector, or economy to determine trading opportunities. Referred to as fundamentalists, these traders pay close attention to changes in economic indicators such as interest rates, employment rates, and inflation.

Fundamental analysis helps traders and investors to gather the right information to make rational decisions about what position to take. And you can also have a clear picture of general health of the economy and predict economic conditions very well.

What Does Fundamental Analysis Entail?

Fundamental analysis is carried out based on all of the external factors that can influence a currency or a currency pair, and can change the supply and demand balance, including the economic events that influence the forex market, the political and geopolitical events and the seasonality.

Economic Events

This is by far the most important and the most influential part of the fundamental analysis, and it takes one thing to master it: the economic calendar. The information in the economic calendar is released by central banks, reserve banks, and private companies to show the performance of the economy, which may in turn influence the value of an economy's currency.

The trick to trading the fundamental aspect of economic releases is to determine when you want to make your commitment. A trader must prepare for these releases and must know about them in advance.

Political and Geopolitical Events

Another important part of the fundamental analysis consists of political and geopolitical events that surround a currency pair, including wars, elections, power changes and natural disasters.

The breakout of a war or a ceasefire significantly affects the valuation of currencies issued by the nations at war. A change of regime or political majority can significantly affect the value of a nation's currency.

A nation that has had a change of power could experience a complete revaluation or devaluation of their currency. And When a country is hit with a substantial natural disaster, that nation's currency typically appreciates in the short term but could be adversely affected in the long term.

Seasonality

The seasonality is related to some seasonal factors that aren't related to weather like "January Effect", a perceived seasonal increase in equities prices during the month of January.

In addition, at the end of the calendar year many investors will sell equities that have declined throughout the year in order to claim capital losses on their taxes.

What Are the Approaches to Conduct Fundamental Analysis？

Fundamental analysis can be either top-down or bottom-up. Majorly there are two approaches for fundamental analysis - Top-down Analysis and Bottom-Up Analysis. Besides, there are also another fundamental analysis way called balance of trade and interest rates.

Top-down Analysis

Top-down Analysis begins by analyzing broad brush macroeconomic factors such as interest rates, inflation, and GDP levels, an investor tries to determine the overall direction of the economy and identifies the currency pairs that present a profit potential.

Bottom-Up Analysis 

Conversely, Bottom-Up Analysis starts with analyzing the currency pair working upwards to aggregate macroeconomic information.

Balance of Trade and Interest Rates

These factors are the main drivers of currencies. If a country has a trade surplus, it means that its goods and services are in greater demand, leading to greater demand for its currency, which pushes up its relative value. Similarly, higher relative interest rates lead to an inflow of cash that lifts the value of money.

Conclusion

For those who are not purely technical, performing fundamental market analysis before initiating a trade can make a significant difference in the overall success of a trading position.

Rather than establishing entry and exit points, fundamental analysis seeks to understand the value of an asset, so that traders can take a much longer-term view of the market. 

But you can improve your chances of finding trade opportunities and successfully managing your trades by combining fundamental and technical analysis.