Fundamental analysis is a way of understanding the changes in market valuation by analyzing economic, social, and political forces that affects the supply and demand of an asset.
In Forex, the idea behind this type of analysis is that if a country’s current or future economic outlook is good, their currency should strengthen. The better shape a country’s economy is, the more foreign businesses and investors will invest in that country. This results in the need to purchase that country’s currency to obtain those assets.
Forex traders who utilize Fundamental analysis often keep one eye focused on the market price action, while keeping the other financial news resources. They will study the news for information on political climate, international relations, natural disasters and other worldly events in order to determine what might be coming up in the trading arena.
Fundamental factors that many traders use when deciding whether to enter, stay with a trade, or exit, besides those already mentioned, include unemployment rates, inflation, fiscal policy changes, and stocks/bonds/money markets. If an Earthquake occurs in India, for example, fundamental analysts will keep a close eye on the impending changes in the value of Indian currency to determine when to buy or sell.
For example, let’s say that the U.S. dollar has been gaining strength because the U.S. economy is improving. As the economy gets better, raising interest rates may be needed to control growth and inflation.
Higher interest rates make dollar-denominated financial assets more attractive. In order to get their hands on these lovely assets, traders and investors have to buy some greenbacks first. As a result, the value of the dollar will most likely increase.