If you are just getting into forex trading and are in the process of building your foundational knowledge surrounding it, you are in the right place. Understanding the terminologies and deciphering what time does the market open might leave you in a state of limbo if you don’t even have your basics sorted.
This article will explore everything you potentially need to know about the fundamental analysis in forex trading, which is considered one of the two main methods of looking up investment opportunities in this niche.
Understanding Fundamental Analysis
So, what is fundamental analysis? If we had to explain this terminology in simpler terms, fundamental analysis in forex trading is the process of evaluating the market by leveraging different data sources to ascertain the fair value of an asset.
Using fundamental analysis is a holistic and comprehensive way to understand the highs and lows of a commodity involved in forex trading. Instead of using it to buy stocks, fundamental analysis is an integral method that most traders use in asset classes.
A fundamental trader looks into a potential investment from multiple viewpoints. Instead of keeping their research 2D, the trader explores all the significant data that could influence the price and the importance of the asset in question, for example, the economic data, political data, etc.
Additionally, fundamental traders are extremely holistic with their market approach. Their extensive research about a product or asset’s fair value is to ascertain whether or not the product is overpriced or under-priced.
What is the Relation between Fundamental Analysis and Fair Value?
Now that you have a brief rundown of what fundamental analysis is, understanding its significance in determining the fair value of an asset or commodity in forex is crucial.
If we had to simplify things further, the primary principle of fundamental analysis is that every product has a fair valuation. Furthermore, even if the market ends up overpricing or under-pricing the object in question, it will soon return to its original value despite the market turmoil.
Several factors determine the fair value of an asset or a currency. It can be influenced by central bank actions, economic stability, demand, retail consumption, etc.
What Elements Influence Fundamental Analysis?
As we have been saying from the beginning, fundamental analysis isn’t an independent concept. Instead, it is a culmination of multiple factors or elements. Some of the most important influencing factors that deserve a mention are:
- Economic data – Understanding whether or not the relative economy surrounding the asset is shrinking or growing plays a crucial role in fundamental analysis. If the GDP is growing, it also indicates that there is significant economic growth. Both production reports and employment play a major role in determining the economic stability in an area.
- Central bank influences – You might not realize this as a beginner forex trader but the central banks hold a lot of power in determining the stability of the market. Their decisions have the potential to cause rampant volatility too. A sudden increase or decrease in the interest rates can lead to heavy impacts on the currencies. Fundamental analysts are now focusing on monetary policies that could heavily influence the forex trading scene.
- Inflation – Inflation is an integral part of our life that’s not going to change anytime soon. For those who aren’t aware, inflation happens when the purchasing power of a currency reduces over the years. Not just commodities and assets, inflation has a direct impact on the forex trading market too.
- Politics – Drastic and frequent political shifts in a country has the potential to impact the finances of a country. Not just local or country-based politics, geopolitics is also an integral factor that influences the fundamental analysis.
- Natural disasters – Drastic natural disasters directly impact the market’s economy, leading to a lack of stability and volatility in forex trading.
Are there any Downsides to Fundamental Analysis in Forex Trading?
Fundamental analysis is a lucrative way to study the market and find out profitable opportunities in the forex trading scene. However, like every other asset influencing the market, certain factors are considered downsides of fundamental analysis in forex trading.
- Firstly, there’s never a 100% assurance that your chosen asset will gravitate towards the fair value that you have determined for it. Since the world is so unpredictable, anything can happen the next moment to completely upturn everything you hoped for.
- Secondly, fundamental analysis involves a lot of data to be looked into and read about. It is time-consuming and a very confusing affair to indulge in for beginners.
If you want to cement your place in the forex trading niche, knowing the meaning and significance of fundamental analysis is key. Not only does it help you determine the profitability of your target market, but it also enables you to make the right trading decisions that reap a higher profit.