What is fundamental analysis?
Fundamental analysts collect data about what is happening in the economy and try to understand how these economic conditions impact the current value of a particular currency, as well as predict what might happen to the currency’s future value. Many things can impact the state of the economy, including monetary policy set by government agencies, capital and trade flows, production, and employment. Understanding these key economic indicators and how they impact the value of money is critical for currency traders.
Watching the flows of money is part of the fundamental analysis. Money flows in waves. Watching those flows can help you determine where your next trading opportunity might occur. There are two types of money flows you need to watch – capital flows and trade flows.
Capital flows gauge the amount of a currency that is bought or sold for the purpose of capital investment. When you read that a country has a positive capital flow balance, this means that foreign inflows of capital exceed the outflows of capital. The reserve is true if there is a negative flow balance.
Trade flows is another key indicator of where money is going can be seen. The best indicator for watching trade flows is a country’s net trade balance. Countries that are net trade exporters, meaning they export more goods and services than they import, will carry a net trade surplus. Countries with a net trade surplus are more likely to see their currencies rise in value.
Fundamental analysts look at the underlying economic conditions and use that information to attempt to predict a currency’s current and future valuation. This is very different from technical analysts who believe all the information that is needed to predict the price of a currency and a directional trend is a database of historical prices.
As a trader, you should make use of both fundamental and technical analysis. Technical analysis provides a map of analyzing a currency’s price action and helps you recognize trends in those prices. Fundamental analysis helps you to determine what is actually happening in the market to explain the trends you see in your technical analysis. Using both types of analysis will help you make better trading decision.