Forex Trading - What Is Fundamental Analysis?

If you want to be a smart trader, you have to be able to analyze the market correctly and predict what the price movement is going to be. This is true no matter what you are trading, whether it be stocks, commodities, bonds, currency or any other form of security.

This type of analysis can be done in two different ways, with fundamental analysis or technical analysis.

With technical analysis, you study the prices. Your goal is to analyze the history of the price movements in order to try to predict future prices.

Fundamental analysis, the other hand, is the study of one nation's overall economic health. You might also think of this as "big picture" analysis. This focus is on the idea that the health of a nation's economy will affect both the supply and demand for its currency. In turn, this will affect the price of the currency itself.

As example, if the US economy's health is good and its economy is on the rise, one would expect that the value of US dollar will also rise and currency traders will want to invest heavily in it. This type of "bullish" behavior becomes a self-filling prophecy so that the US dollar does, indeed, rise in value.

Although it seems like a pretty simple concept, in fact, judging the "health" of a nation is not easy. There are many factors to be considered. Therefore, two traders may look at the same figures and interpret the data in different ways.

Fundamental analysts look at various economic indicators to see how strong the economy is. Some of these indicators they analyze include the interest rate, unemployment rate, gross domestic product (GDP), and consumer price index.

Government and non-governmental agencies and bodies regularly release these types of reports; find schedules of upcoming releases for those you focus on and make note of them. Then, keep an eye on them and see what their effects are on currency prices for the country or countries you follow.

You should note, though, that the numbers contained in the report are not what have the greatest impact always. Rather, it's the relation of the numbers in that report as compared to what had been forecasted previously.

In other words, a hike in interest rates may not have a significant impact if forecasters indeed thought this was going to happen. However, if they were expecting interest rates to remain steady and there actually was an increase, this may in fact have a large impact on currency prices.

There is a disadvantage to fundamental analysis, which is that it can be a little too broad-based. Although it's a wonderful tool to predict overall economic growth and price changes, it doesn't give enough details for investors to target specific exit or entry points. This is why technical analysis is as valuable as "big picture" analysis is. Technical analysis does give you that "fine point" analysis.