Forex Trading Basics Tutorial 6 -- Basic Forex Fundamental Analysis

This Forex Trading tutorial covers the fundamental analysis of currencies, starting with looking at the currencies central banking websites.  In addition, you’ll learn about how the economic information will assist in creating predictions on the upward or downward trend of a currency pair.

Forex traders know that the way to make money in currency trading is done by placing bets on the direction two different currencies will go.  The pairs are usually priced with one unit of the first currency buying a set number of units of currency of the second currency.  For example, take the Euro and the US dollar:  The EUR/USD pair may be quoted as 1.31.  This means that 1.00 units of EUR will buy 1.31 units of USD.  Or, put another way, one Euro will buy 1.31 US dollars.  If a Forex trader decides to make a long EUR/USD trade, he will profit if the exchange rate changes, so that one Euro will buy more than the old amount of 1.31 US dollars, perhaps one Euro now buys 1.40 US dollars.  This scenario will allow the Forex trader to profit and make a winning trade on the EUR/USD trade.

Let’s back up a moment now to see how to place a winning trade.  In the above example, the trader needs to now the future amounts of how much one currency can buy of another currency.  One of the easiest ways to determinate this is to watch a country’s growth rate.  As in the EUR/USD example used previously, if a trader watches the European Union (the first currency of the pair) and sees that it is growing at much quicker rate than the United States (such as the second current of the pair), this will cause the Euro to gain in value faster over the US dollar. Watching a country’s currency growth rate is called currency fundamental analysis.

The Basics of Currency Fundamentals

The gain of the Euro over the US dollar will be from many different factors, but mainly from the increase of demand for the Euro from trade in addition to the potential for an increase in interest rates for the Euro.  One of the main reasons that a currency side with greatest amount of growth will move higher and gain in value faster than its companion pair is due in part to interest rates.  Interest rates are a key element in currency trading fundamental analysis. Typically, a country’s growth rate is structured in three phases: increasing, decreasing or no change.  Growth means a country’s economic outlook is good and will continue to grow until inflation begins.  With central banks keeping a close eye on the situation, they may consider raising interest rates of the home currency to avoid inflation.

Fundamental Analysis, Central Banking, Growth Rates and Inflation

When a country decides to raise interest rates, it isn’t an arbitrary decision.  Often times a higher interest rate on the home currency will make it more expensive to borrow in that currency.  If there is a higher price to be charged for borrowing, investors may seek to slow their business equipment and inventory investments or reduce their trades.  Businesses may skimp on expansion plans due to the rate increase because it will cost more to borrow the same amount of money.  Higher interest rates also mean higher borrowing costs both at the bank and at the money market level.   In this way, raising interest rates can cause a slow down or “cooling off” of the economy.  It can result in fewer projects getting funded, less growth, the economy goes into a slowdown and there is less inflation.

Higher Interest Rates Mean Higher Currency Values

Currency traders make a will notice that one currency of a pair will have a slightly higher interest rate than the other in the same pair.  If so, they will buy the currency of the pair with the expectation that it will go higher on the interest rate and eventually, higher on its exchange value against the second currency.  Currency market news is in constantly updating, with new data coming out continuously and traders the world over are all simultaneously seeking the same types of data to make their trades.  With so many worldwide traders looking at the same fundamental information, it can have the effect of “pushing up” the price of the currency with the “chance” of a future increase in the interest rate.  This effect is common and occurs within days or hours and is often the reason why some currency pairs move in giant leaps in a single direction from day to day.

Using Central Banking Websites as a Source of Forex Information

Note that currency traders seek all forms of fundamental information that will give them insight on the future direction of a currency’s interest rates.  By far the best place to find this information is on the countries’ own central banking websites.  Take the time to visit the websites of the country whose currency you are interested in.  Perhaps you heard from another trader that oil prices are going up and up and that the price of the Norwegian Kroner is based indirectly upon the increasing price of oil (because of Norway’s rich oil reserves).  Researching the Norges-Bank website at http://www.norges-bank.no/en/ may yield more information and indicate the growth rate of Norway in comparison to its trading partner’s growth rate, the Euro http://www.ecb.int/ .  Now, compare that information to the news you have picked up plus the broker’s reports and you might conclude that the NOK will strengthen against the EUR.  Should Norway increase interest rates due to inflation, while the European Central Bank lowers its interest rates due to a slowing economy, now you’ve got a trade with a very high potential of creating excellent profits.  A professional trader may even do a longer term trade (6 months or longer) with up to 10% of his entire Forex capital buying power in a Short EUR/NOK (“short” meaning here that the trader has “sold” EUR and used the proceeds to “buy” NOK).

Use the Bank of International Settlement located on the world wide web at http://www.bis.org/cbanks.htm to find all the central bank websites.  Additional information from broker’s reports, news reports, market data and stock market information should also be reviewed. Traders look for high quality, highly reliable, unbiased outlets for sourcing fundamental information.

In the next tutorial, the overview will include good ways to use charts to find the best times to trade currency pairs.  Graphic examples of two common charts used in currency trading will be provided.

 

 

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tothetick

Professional team of writers/analysts analyzing the financial markets.

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