By: Carl Hayes
Most traders are very well aware that market movements can be unpredictable and difficult to interpret, and this conviction is confirmed by a number of studies published by academics with the conclusion that there’s a significant degree of randomness to the price action. But although this is true in the short term, even a cursory examination of the EURUSD chart over a multi-month period would suffice to show that there are forces which drive price trends with a lot more clarity than what is evident in a day’s price action. Fundamental forex analysis seeks to discover and identify these forces for using them profitably in trading.
Forex Fundamental analysis has been creating millionaires for at least two millenniums. Traders in agricultural commodities and contractors for armies have been creating fortunes since Roman times, and the Chinese annal Shiji, created a short while before the birth of Christ, records examples of speculators who became wealthy by exploiting supply and demand imbalances for immense profits. Although times and tools have changed, the rules of fundamental analysis have remained the same. Identify the long-term causes creating the imbalances, and exploit them by following the trends for profit.
Similarly, in the recent period between 2002 and 2007, carry trade pairs, commodities, and the Euro appreciated strongly against the dollar. This trend which lasted over five years survived many different economic and political events, and different technical configurations predicting its end. Its power was the result of strong central bank policy action in the U.S. which increased the supply of U.S. dollars in order to ease credit standards. As long as this situation lasted, traders were willing to sell the dollar, because they were aware that the more powerful financial actors, such as governments, banks, and corporations which were benefiting from the situation would do their best to maintain it. Only when they were powerless to stop its eventual breakdown did the trade lose its validity. If a trader had analyzed central bank statements, and policies correctly in 2002, he would have registered giant profits through this five-year long period. Fundamental analysis is about discovering these stronger underlying trends behind economic events and currency trends.
Traders apply fundamental analysis mostly by analyzing news and statistics released by central banks and government agencies. Our discussion so far should have made clear that the fundamental analyst does not trade the news, but the big picture created by it. The data itself is only important as far as the place it fills in our scenario. Our aim is not to trade the immediate reaction to news, but the long term market response which manifests itself in months, not hours, for the most significant releases.
In short, the fact that there have been many billionaires self-made through fundamental analysis should be enough to prove the validity of this school of analysis. Fundamental analysis is an ancient, efficient, and powerful discipline that will only benefit the smart trader who takes the time to study and practice it.