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How to Perform Fundamental Analysis in Forex Trading

Fundamental analysis in forex trading is typically performed through evaluating the economic, political, and other related qualitative and quantitative factors that affect foreign exchange rates. These factors include recurring factors such as interest rates, inflation, GDP, unemployment data, and trade balance, as well as the non-recurring factors such as some geo-political events.

For real-time forex trading, fundamental analysis can be started with interest rate (see the live interest rate page). Interest rate may be the most important overall factor in determining exchange rates between currencies. In general, money tends to move to places with higher interest rates. However, it was not always the case. Very often it is not the higher interest rate per se but the expected raise or cut of an interest rate that moves the forex market. When a central bank or government is expected to raise its interest rate, the value of the associated currency would normally increase in the forex market. On the contrary, if the interest rate is speculated to go down, the currency's exchange rate s would generally decline as well.

Then get familiar with key economic indicators (see Forex Fundamental Analysis Tool: Key Economic Indicators). For most countries, the key economic indicators include Consumer Price Index (CPI), balance of trade, employment / unemployment, Gross Domestic Product (GDP), industrial production, and Producer Price Index (PPI). However, each country may have its own unique economic indicators (see Forex Fundamental Analysis Tool: Key Indicators for Most-traded Currencies).

Check the economic calendar (here are the latest update of the calendar) and be prepared for the release. Compare the release data with the forecast, and pay attention to the surprise.

Apart from economic indicators, there are also other tools that can be used to gauge the strength of a currency. Among them the most widely used are Commitments of Traders Report (COT), US Dollar Index (NYBOT) and sovereign ratings.

Commitments of Traders Report (COT) is a weekly report published by the Commodity Futures Trading Commission (CFTC) of USA, listing current contract commitments by 3 groups of futures market participants: Commercial, Non-commercial, and Non-reportable. Issued on Friday, the COT report provides a “breakdown of each Tuesday's open interest for markets in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC” (CFTC). COT is often used to estimate positioning and forecast price trends in forex trading (see How to Use Commitments of Traders Report (COT) in Forex Trading).

US Dollar Index (NYBOT) is a measure of the value of the U.S. dollar relative to a basket of foreign currencies including euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss. The index is a weighted geometric mean of the US dollar's value compared to the currencies in the basket using March 1973 as the base period (100). In forex trading, US Dollar Index is often use by traders to assess the strength of US dollar.

Sovereign rating is another method of assessing the strength of the world's currencies. Sovereign ratings by S&P and by Economist Intelligence Unit are available free for forex traders. (See Fundamental Analysis Tool: Sovereign Ratings).

With fundamental analysis, a forex trader can achieve an understanding the underlying forces for forex price movement. Thus an edge is added on top of the technical tools.

Related topics:

How to Use Commitments of Traders Report (COT) in Forex Trading

How to Choose a Best Forex Broker

How to Perform Technical Analysis in Forex Trading

Use Parabolic SAR in Forex Trading

Measuring Sentiment in Forex Trading

Approaches of Risk Management in Forex Trading