Forex indicators are used to help identify high probability trade entry and exit points. Find out all about indicators and how to use them right.
Fundamental analysis is the study of how economy of the country affects its currency rate, which mainly involves interpretation of statistical reports and economic indicators. Hundreds of economic news and reports released daily allow, to some extent, to predict whether the currency value will appreciate or depreciate in future and when reversal of the current trend may be expected.
Date and time when a particular report or indicator due to be released is scheduled in advance and can be found in the Economic Calendar. It is the main tool analysts use to determine the impact news may have. It also shows experts forecasts of the data to be announced.
Those trading in the foreign exchange market (forex) rely on the same two basic forms of analysis that are used in the stock market: fundamental analysis and technical analysis. The uses of technical analysis in forex are much the same: the price is assumed to reflect all news, and the charts are the objects of analysis. But unlike companies, countries have no balance sheets, so how can fundamental analysis be conducted on a currency?
Since fundamental analysis is about looking at the intrinsic value of an investment, its application in forex entails looking at the economic conditions that affect the valuation of a nation’s currency. Here we look at some of the major fundamental factors that play a role in a currency’s movement.
The Best Forex Fundamental Indicators
Inflation is a sustained increase in the amount of currency in circulation – which in turn increases the price of goods and services. With this in mind, inflation is one of the most important of all Forex fundamental indicators, as it demonstrates how healthy an economy is. It is important to understand that even through the power of central banks, governments can’t really control inflation.
The level of ‘healthy’ inflation’ is defined by each state according to the needs of their economy. Developed economies set their aim at around 2%, while developing economies can go up to 7% without causing any panic among investors. Depending on whether the actual inflation rate is above or below the set target, the country can be in a state of hyperinflation – whereby too much money has been introduced into circulation, or negative inflation – which means that there is too little in circulation.
Either state has its own equally damaging ramifications. Any deviation from a set inflation rate can be considered a fundamental indicator. Inflation is difficult to control because there are many sources for money to appear from, and many places that it can disappear. Today, currencies are not backed up by commodity standards, which means that they can be added into circulation by private banks via a fractional reserve system.
Also, because financial assets don’t obey national borders, foreign entities can accumulate and keep large sums of currencies until they see fit, to then discharge them back into the market at a later time. All of this complicates things exponentially for fiscal policy makers. In terms of Forex trading, the higher the rate of inflation, the quicker the currency depreciates, and the less reliable of an asset it is for foreign investors, with both resulting in weakness.
Interest rates are simply the value charged by central banks for lending money to private banks. They are a primary tool used to regulate inflation. Interest rates are set by central banks, usually notifying the public beforehand during press conferences, to avoid unnecessary market turmoil. Commercial lending rates walk hand in hand with central bank interest rates, since private banks can’t lend cheaper than they borrow.
It is this very connection that makes interest rates a power leveller of the economy, and therefore, a major Forex fundamental analysis indicator. In a well regulated, well balanced economy, central banks may raise interest rates in order to cut the pace of money lending, and to ‘cool down’ an economy by decreasing inflation. This cuts consumer spending, helping to bring growth to a more manageable level.
Conversely, if there isn’t enough money in circulation, and the government is eager to spur the economy, they cut interest rates, making it easier and cheaper for businesses and individuals to borrow money.
For a Forex trader, interest rates are the best multi-purpose fundamental indicator, since an increase in interest rates generally forces a currency to appreciate, since there is a cut in supply. Conversely, when interest rates are lowered, the rate for borrowing increases and the currency depreciates. There are a few important things to note here. First of all, it is important to learn to distinguish between nominal or base interest rates and what are called the ‘real interest rates’.
The real interest rates are nominal interest rates minus the expected inflation. For example, at the beginning of 2015, the Bank of Russia set an interest rate for the Ruble at 17%, in response to panic on the market. The Ruble consequently plummeted 200% against the US Dollar within mere minutes. The newly introduced level of inflation was approximately 16%.
Secondly, central banks only regulate the supply of currency, while a demand for it originates through political and economic stability, along with the willingness of investors to use the currency as a predictable and reliable financial asset. High interest rates in a stable economy attracts investors, while high interest rates accompanied by hyperinflation attracts only speculators.
Gross Domestic Product (GDP)
In an economy, GDP shows the totality of the value of goods and services produced over a particular period. An increase or decrease in the GDP can gauge whether the economy has expanded or contracted. An expanding economy implies that unemployment levels declined, and the welfare of households improved. Conversely, a contracting economy means more jobs were lost, and some families are worse off.
Employment Report: Forex Fundamental Indicators
This data shows the prevailing state of the labor market in an economy. While the report contains several data such as the number of jobs in different sectors of the economy, the demographics of the employment trends, and how long it takes for job seekers to find employment, the most significant aspect of the employment report is the national unemployment rate.
Central Bank Interest Rates
The interest rate data published by the central banks is arguably the most significant economic indicator in the forex market. Here are some of the reasons why the interest rate is essential.
In many cases, it is enough to be up to date with these fundamental indicators to understand the possible market trends in Forex. But of course, if you wish to get a more detailed picture of the market, you should not limit yourself to only these indicators, especially if you pose yourself as a purely fundamental currency trader.