(Newswire.net — June 15, 2021) — The world of forex trading offers many exciting opportunities to generate profits by risking your capital, but to make the most of it, you need to do more than simply brush up your trading skills! You also have to improve your knowledge regarding several other factors that can drive moves in currencies. Forex signals are one of the most important and popular tools that you might already be using as a forex trader, but they only tell you part of the story. Be it automated or manual forex trading signals, technical analysis forms an essential part in the generation thereof. However, to derive the maximum value from these signals, you need to be able to perform your own fundamental analysis of them, and to understand what factors are causing the movements in specific currency pairs.
We know that forex trading is all about capturing price action in currency pairs – it’s about knowing how a currency pair is likely to move and by how much, entering a trade based on this knowledge and exiting at just the right level to make profits on the trade. While technical indicators let you know how a forex pair is likely to move and how much movement to expect, it always helps to understand the background information on exactly what caused the currency pair to move in the first place. This is the essence of fundamental analysis, and knowing this can help you place better, more informed trades, with potentially lower losses and higher profits. When it comes to forex trading, knowledge is indeed power. So, what exactly does fundamental analysis of forex signals involve?
Macroeconomic events
Financial news is one of the biggest factors that drives movements in the forex market, causing some currencies to weaken and others to gain strength. The performance of a country’s overall economy, monetary policy decisions taken by the nations’ central banks, decisions on fiscal stimulus, and a range of other factors can all have a significant impact on the value of a country’s currency, and drive price action in the world of forex trading. Let’s consider the most popular currency, the US dollar, to understand this better. When the US central bank, the Federal Reserve, announces changes to its monetary policy or its interest rates, it immediately impacts the value of the dollar. The Fed is likely to adopt a hawkish tone in its monetary policy or hike interest rates when it feels more confident about economic growth in the US. A more confident outlook about the economy serves to strengthen the currency – in this case, the US dollar.
Microeconomics
It’s not just the larger macroeconomic events that impact the value of a currency. The release of important economic data from a country can also cause fluctuations in its currency and drive price action in corresponding currency pairs. Economic data releases, such as the GDP, inflation, employment reports, consumer confidence, retail sales, business sentiment and more, also have a significant impact on the country’s economy, how it is perceived internationally, and therefore, also on the currency. Let’s explain this with an example: on the day of the GDP release by the US, forex traders are likely to trade the US dollar with considerable caution, hesitating to make moves ahead of the figure coming out. If there is a likelihood of the US posting stronger GDP figures for the quarter or the year, there is a sense of increased confidence in the nation, which will cause bullish trading in the dollar. If, however, the GDP report reveals weakness in the economy, compared to the previous quarter or year, traders will lose confidence in the dollar and sell it, causing its value to drop against other currencies. Weaker economic data from a particular country reduces the overall confidence in its economy, and in turn, drives its currency into bearish trading.
Stock markets
The forex market shares a close correlation with equity markets. When the market sentiment is upbeat, it’s not just the stock markets that perform well. A higher risk appetite in the global financial markets also gives riskier currencies a boost, while diminishing the appeal of safe haven currencies. Risk currencies include commodity currencies like the AUD, NZD and CAD, and even emerging market currencies. When traders have a higher appetite for risk, these currencies trade bullishly. On the other hand, safe haven currencies like the JPY, the CHF and sometimes even the US dollar (considered a reserve currency) turn bearish when markets trade with a risk-on sentiment. However, when the stock markets are down, it indicates a decline in investor confidence, which can weaken the corresponding nation’s currency and send it lower against other currencies. For instance, if Wall Street has a bad day, chances are the US dollar will also turn bearish, as traders move away from the greenback towards the currencies of countries that have better-performing equity markets.
Geopolitical developments
While the factors discussed above have a more direct impact on the value of currencies, forex markets can also see significant volatility whenever geopolitical tensions flare up around the world. For instance, the US-China trade war not only wreaked havoc on the US dollar and the Chinese yuan; it caused heavy fluctuations in the exchange rates of several other currency pairs as well. This is because, in this era of globalization, the economy of one country is closely interlinked with that of other countries, and whatever happens to one nation has a ripple effect on other economies as well. In the case of the trade war between the US and China, the economies of Japan and Australia were also severely impacted, as both these nations have a strong trade relationship with China. When China’s economy falters, or its trade is impacted, the Japanese and Australian economies also come under strain, and as a result, the JPY and AUD also see increased volatility.
Let’s take another example: geopolitical tensions in the Middle East have a direct impact on crude oil prices, as the leading oil producers of the world are located in this region. When the value of crude oil is impacted, commodity currencies like the Canadian dollar also see significant movement. This is because the value of the CAD is closely interlinked with crude oil prices, as oil is one of the most important exports from Canada.
In conclusion..
Now you see why, as a forex trader, it is not enough for you to learn how to use technical indicators to analyze moves in currency pairs. Having ample knowledge about financial markets makes you a more informed trader, and it can give you an edge in making more profits from your trades. Whenever you receive a forex trading signal, it helps to understand the fundamental analysis behind the particular trade idea. Do your own research into what has caused a currency pair to move in a certain way. You can increase your profits through fundamental analysis by extending your take profit levels beyond what the signal recommends, in case you feel that the fundamentals could cause greater movement in the currency pair.
In addition, fundamental analysis can also help you place trades in correlated currency pairs, and generate more profits from each forex signal that you receive. Let’s try to understand how this works with an example: let’s say you receive a sell forex signal for AUD/USD from your signals provider. We know that the AUD/USD currency pair shares a close correlation with the NZD/USD. After analyzing the fundamentals behind the signal, you can gauge whether there is a possible impact on the NZD/USD. If so, you can enter a selling trade in the Kiwi as well, which will give you a shot at earning more profits from a single trade idea.