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A fundamental trading strategy consists of strategic assessments in
which a certain currency is traded based on virtually any criteria
excluding the price action. These criteria include, but are not
limited to, the economic condition that the country the currency
represents, monetary policy, and other elements that are fundamental
to economies.
The focus of fundamental analysis lies on the economic, social and
political forces that drive supply and demand. There is no single set
of beliefs that guide fundamental analysis, yet most fundamental
analysts look at various macroeconomic indicators such as economic
growth rates, interest rates, inflation, and unemployment. Several
theories prevail as to how currencies should be valued.
Alone, fundamental analysis can be stressful when dealing with
commodities, currencies and other "margined" products. The reason for
this is that often fundamental analysis does not provide specific
entry and exit points, and therefore it can be difficult for risk to
be controlled when utilizing leverage techniques.
Currency prices are a reflection of the balance between supply and
demand for currencies. Interest rates and the overall strength of the
economy are the two primary factors that affect supply and demand.
Economic indicators (for example, GDP, foreign investment and the
trade balance) reflect the overall health of an economy. Therefore,
they are responsible for the underlying changes in supply and demand
for that currency. A tremendous amount of data is released at regular
intervals, and some of this data is significant. Data that is related
to interest rates and international trade is analyzed very closely.
Interest Rates
If there is an uncertainty in the market
in terms of interest rates, then any developments regarding interest
rates can have a direct affect on the currency markets. Generally,
when a country raises its interest rates, the country's currency will
strengthen in relation to other currencies as assets are shifted to
gain a higher return. Interest rates hikes, however, are usually not
good news for stock markets. This is due to the fact that many
investors will withdraw money from a country's stock market when there
is a hike of interest rates, causing the country's currency to weaken.
Knowing which effect prevails can be tricky, but usually there is an
agreement among the field as to what the interest rate move will do.
PPI, CPI, and GDP have proven to be the indicators with the biggest
impact. The timing of interest rate moves is usually known in advance.
It is generally known that these moves take place after regular
meetings of the BOE, FED, ECB, BOJ, and other central banks.
International Trade
The trade balance portrays the net
difference (over a period of time) between the imports and exports of
a nation. When imports become more than exports, the trade balance
shows a deficit (this is --for the most part-- considered
unfavorable). For example, if Euros are sold for other domestic
national currencies, such as US Dollars, to pay for imports, the value
of the currency will depreciate due to the flow of dollars outside the
country. On the other hand, if trade figures show an increase in
exports, money will flow into the country and increase the value of
the currency. In some ways, however, a deficit in and of itself is not
necessarily a bad thing. A deficit is only negative if the deficit is
greater than market expectations and therefore will trigger a negative
price movement.
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