New traders are faced with the challenge of deciding the best trading strategy to use. Many believe in technical analysis while others believe solely in fundamental analysis. On the other hand, other traders believe in a hybrid strategy, combining the two. The latter have the upper hand in making sound entry and exit strategies. In this article, I will focus on fundamental analysis and how you can use it to make excellent investing (trading) decisions.
What is Fundamental Analysis?
In the forex market, currency pairs move as a result of a number of factors such as: news, economic data, and even natural phenomena. When some news break, traders expect a reaction to the financial market. A good example of this happened in January 15th 2015 when the Swiss National Bank (SNB) scrapped the 3-year old peg of 1.20 CHF per Euro. This resulted in the sudden strengthening of CHF against all the major currencies leading to huge losses. Forex brokerage company FXCM lost more than $200 million. Fundamental analysis therefore calls for a deep analysis of the forex market before making a trade.
The Economic Calendar
The economic calendar which is offered by many forex brokers is a very important tool traders use before making or leaving a trade. The calendar shows the schedule of economic events that are expected to happen in the financial market. The calendar has 5 important categories that traders must use: expected time of the event, the event name, the currency to be affected, the actual (anticipated figure), the forecasted figure, and the previous figure.
How To Use the Economic Calendar
The information in the economic calendar is released by central banks, reserve banks, and private companies to show the performance of the economy. After the release of the data, the market will react in favour or against the currency. For instance, if data showing an improvement in retail sales is released, this will show signs of a strengthening economy. As a result, the currency to be affected will likely become strong. However, if the retail sales decline, it will imply that the economy is not doing very well resulting to a weakening in the currency. For this reason, successful traders follow a certain rules to avoid losses during the release period.
- a. Always check the calendar in advance.
To become successful, you need to have the daily or weekly calendar in your fingertips. To achieve this, you need to check your calendar every week and note down the expected data for that week. Having this information will help you avoid being caught up in the release volatility.
- b. Avoid the market during the release time
The fact is that no one knows the exact number that will be released and how it will react. Quite often, 30 minutes before and after the release of data is usually the most volatile part of the market. It is during this period that most traders lose most of their money.
- c. Understand the value of the data
To level of volatility caused by the data differs. It is therefore important for the trader to identify the data that will likely cause major movements to the forex market. In the economic calendar, there are 3 categories of data which are represented differently according to the broker. For investing.com (which is my favourite calendar), the value of the event is usually represented by bulls where 1 bull represents low volatility, 2 medium volatility and 3 high volatility. You should pay close attention to the event with 3 bulls. Also, it is important to pay close attention to event with 2 bulls, especially when more than one event is being released at a particular time.
The Top 5 Market Moving Events
To understand the calendar better, traders need to learn 5 important market moving events. These events are: interest rate decision, growth rate (GDP), private sector spending, employment (farm and non-farm payrolls), and inflation. For new traders, it is very important to have an in-depth understanding of these metrics and how they affect the forex market.
The economic calendar is one part of fundamental analysis. There are other fundamental analysis information not found in the economic calendar. A good example is when the head of the Federal Reserve appears in a television interview. The information that the chair will tell the interviewer will lead to volatility in the market. When caught off-guard, a trader can make significant losses in such a situation. This situation can be mitigated by watching business related channels such as CNBC and Bloomberg.
To become successful in day trading, the use of fundamental analysis must be combined with technical analysis. Technical analysis will answer questions that fundamental analysis will not provide and vice versa. Therefore, I recommend that new investors take time to learn more about the two strategies.