The concept of fundamental analysis is pretty straightforward – wait for the news to be announced and act upon the news. However, it’s a bit more complicated than that and various concepts have to be kept in mind if you want to be successful trading using this strategy.
What exactly is fundamental analysis?
Quite simply, fundamental analysis is trading by interpreting the news releases affecting a country’s currency. When there’s good news about a county’s economy, the value of that country’s currency rises as traders and investors gain more confidence in that currency. For a Forex trader, news about a country’s economy can be perhaps the best guide to anticipating the direction a currency pair will take.
For example, late last year on the 29th of December 2016, the US Department of Labour released the weekly unemployment claims report. The report showed a lot less unemployed individuals in the US, which was great for the US economy and the Forex market responded in kind:
That single announcement caused a shift of over 1,500 pips, and any trader who was in on that trade would have certainly celebrate a good year. In fact, these economic news releases produce the biggest moves in the Forex market, and fundamental analysts make the most out of them by cashing in.
The most important news announcements are:
- Central banks’ reports which are responsible for a country’s economy
- Non-Farm Payroll (NFP) which reports the number of jobs added in the US
- Balance of Trade (BOT) or trade balance shows how much a country is exporting versus importing
- Consumer price index (CPI) which shows the rate of inflation
- Retail sales report shows the value of goods sold in the previous month to show the state of the economy
- Gross domestic product (GDP) combines most of the above reports to show how a country’s economy is performing, but it is released quarterly although it has a major impact on the markets
Sources of information
The main source of fundamental analysis information is the Forex calendar which lists all the economic news announcements of the week. You can even filter the calendar to only list the most relevant announcements which will have the biggest impact. Besides just informing traders of upcoming news releases, this calendar will also provide the information released in the announcement and even hint at what this might mean for the markets.
However, updating the figures of the Forex calendar is not automatic, and has to be done manually, which means there will be a delay. As a result, you cannot depend on the forex calendar alone for information because by the time you know what the announcement said, the markets will have already responded. So, how do other traders know? Financial news channels. Can you remember in a previous post about becoming a full-time trader I mentioned there would be monthly expenses? This is what I meant. Most of these financial news channels aren’t free, and have to be paid for, but it will be completely worth it especially if your trading strategy relies primarily on fundamental analysis.
By subscribing to one or more of these news channels, you will have access to the live news releases just like every other trader in the world including the biggest traders in the market. This would surely put you ahead of many other traders who won’t have this information and help you get into trades as early as possible.
Making the most out of fundamental analysis
Now that you know about the markets from the various sources, you have to put it in practice for it to have any use, but there are some more aspects to consider:
Understanding the markets
I know that sounds ambiguous, but it is perhaps the most important thing for any trader to learn – what affects every country’s economy. We have already seen some of the major news releases that affect a country’s currency – GDP, NFP, BOT, etc., but what else should you be aware of.
This is where a firm grasp of the commodities market comes into play. News announcements won’t always be about the economy directly, but sometimes it may be about the commodities produced and exported by that country. The image below shows how the Canadian Dollar responded to the news of excess crude oil inventories reported on the 29th of December 2016.
That single report caused the Canadian dollar to drop in value by more than 1,000 pips, another massive move. The point is, as a fundamental analyst, you have to know about what makes a country’s economy tick and how any announcements about that commodity will affect its currency.
You really have to understand the intricacies of the markets and how different regions in the world are interconnected. For example, during the Brexit vote, we saw the value of Sterling pound plummet and those of safe havens like Japan and Switzerland soar, leading to movements like those in the figure below.
All this goes to show is that there is a lot to learn about the markets and a deep understanding of them is required if you want to become successful. In the above example of the Brexit, you can see how currencies like the Japanese Yen and Swiss Franc can be affected by news that doesn’t even concern their countries. This same domino effect can be seen in the value of the Sterling Pound after news releases by the People’s Bank of China since, once again, the two countries are economically intertwined.
This is the kind of understanding I’m talking about that isn’t straightforward but still essential to successful trading.
Fundamental analysis comes down to timing. Every trader will be aware of the time when certain news will be announced simply by checking the Forex calendar, so how do you make use of this information. In the past, it was difficult to get such information, but now every trader has access to it, and although that’s great, it also poses a difficulty.
At the moment of the news release, every trader is acting on the information, which means there are thousands of orders simultaneously, and this creates a lot of volatility. In response, slippage occurs and orders may not be processed at the price you were expecting. In addition, spreads also get wider and that can reduce the potential profits to be earned.
So, how do you get ahead of the pack and get an edge? Pending orders. Unlike those orders executed at market price which are exercised on the spot, pending orders are… well, pending. They are more like instructions to the broker for them to execute the trade when the currency pair reaches the price you’re anticipating.
Because they are placed before the period of volatility, they are more likely to be executed at the specified price, despite slippage and volatility, ensuring that the trader gets the exact price they were hoping for.
There are different pending orders:
- Buy limit – you can place this pending order if you believe the value of the currency pair will drop to a certain point and then rise afterwards
- Sell limit – an order to sell the underlying security when the price has reached a peak level after a rally
- Buy stop – a buy order when the value rises to the specified price in anticipation that the value will keep on rising
- Sell stop – an order to sell after the value of a currency drops to the specified value in the hope that it will keep on falling
The last 2 types of pending orders, the buy and sell stops, are the most effective when trading using fundamental analysis. Before the actual news announcement is made, you can place both the buy and sell stops above and below the current price. That way, you are guaranteed to catch the trend whichever direction it goes, and you don’t even have to be at your workstation.
Besides, pending orders also have an expiration date, which means that the pending order which is not activated won’t be exercised and you won’t be in danger of placing an order you didn’t want to.
The other way to trade these moments of volatility is to act fast, that is if you prefer to place the trades manually. However, you should not jump the gun immediately, it’s always advisable to wait a few minutes, even if it might cost you a few pips. The reason is that market sentiment can often times be fickle, and it is best to get a confirmation of the trend using technical indicators before making the trade.
It is not uncommon to find pivot points drawn up on real-time Forex charts by technical analysts, but it isn’t just they who use them. As a fundamental analyst, pivot points are just as important in your trading career. In order to know where to place pending orders in anticipation of news releases, pivot points will be your guides.
For example, if you believe there will be good news about the US economy and want to place a buy stop, where do you place it? The ideal value would be at a resistance level, because positive news could cause a breakout through the resistance level and vice versa. Therefore, you have to make the most out of these pivot points as a fundamental analyst if you want to make the most out of your analysis.
We’ve now covered how fundamental analysis can be used in the Forex market, but for stock traders, here’s a video to help you out. Together with the information in this post, you should be able to trade stocks more effectively: