Why Fundamental Analysis ?

Whilst many traders spend most of their time using technical analysis to forecast in which direction currency prices will go, they would be ill advised not to ignore the fundamentals because an ill-times trade to result in a disaster.

Both global and local news reports are major forces which impact the currency markets. Although news from the financial sector, such as, interest rates and GDP have the firmest impact, so other key happenings can impact the markets too and the non-financial news could be a complete surprise as well as have a big impact on the markets.

Events like the devastation created by Hurricane Katrina or the 2010 Gulf of Mexico oil spill are unexpected events which may impact the foreign currency exchange rates, market and other major markets as well. Or, as in some cases there are planned events which have a heavy impact on market prices. In such cases the only thing that can be done is to limit the damage by setting up stop losses.

A planned event such as a major international conference in a particular country may help the local currency because of investor confidence. On the other hand the countries that were not considered might be affected negatively. So a trader can’t forget about the fundamentals and needs to keep his eyes and ears to the ground.

Another point that traders should bear in mind is that they are trading currency pairs and looking at the fundamentals of one of the pair could lead to missed opportunities. Furthermore, a mindset that only respects one currency of the pair could lead to a problem if for example you were trading dollars short against the sterling pound and you missed a negative news event out of the UK and the dollar suddenly strengthened against the pound.

There is no real excuse for a trader not to do the housekeeping and make sure he is aware of any events which might affect his existing trades or his future trades. Keeping disciplined and staying in the market is prudent prior to a news event in case that damage limitation is required. Forgetting that there are fundamentals could be a recipe for disaster.
Influence of Fundamental Analysis on Your Trade
Fundamental analysis in forex generally examines how a number of governments' economic guidelines influence the currency trading market. The study of fundamental analysis is normally more suitable to the longer time frame rather than short term times frames, although economic news announcements can and does cause high volatility for a short period of time.

It is these daily economic announcements that can significantly influence a day traders trades. As these announcements consist of economic numbers and sometimes a speech by a prominent person in a government or a bank, the market can react quite strongly and a trader’s trade can be heavily negatively or positively influenced.

For example the dollar might be trending upwards and you have taken a dollar long position. A piece of economic news from the US confirms that non-farm payroll numbers for the last month were much lower than expected. This negative figure might trigger a sudden reversal in the dollars fortunes and your profits on your trade are wiped out very quickly. Most of the time these sudden reversals are temporary and only last a few hours or a few days before the original trend is resumed.

This type of event can test a trader’s resolve quite strongly. If the trader has not set up a stop loss he will be torn between cutting his losses, or riding out the downturn in the hope it is not too costly and the dollar will quickly come back to the current levels. If the trader has set up a stop loss it might be set up to close to the entry point and triggered as the dollar slides down. So now the trader has to set up another trade in replacement.

To avoid surprises a trader should not only concentrate on technical analysis but also on fundamental analysis. When setting up a trade the trader should also take into account the upcoming economic news announcements and analyse how they could affect his trades. Many traders use models incorporating empirical data which model what will probably happen when certain economic announcements are made. In this way the trader can work out how his trade will be influenced and attempt to reduce the short term impact by the correct use of entry and exit points.