How To Conduct Fundamental Analysis in Forex?

This video looks at the five key drivers for Fundamental Analysis and how they affect currency prices.
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Conduct Forex Fundamental Analysis

Just quickly following up with a question from a subscriber asking us what process can they follow to actually conduct fundamental analysis in Forex. So firstly, thanks for the question.

Now this is a good time to just quickly discuss a key reason for why fundamental analysis is so important for trading the markets.


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Whether we’re trading currencies, equities, commodities, or fixed income, when we trade, we’re not trying to be economists, right? So we’re traders. We look at the same things that economists might look at, but we’re not implementing that information in the same way.

So when we are conducting our fundamental analysis, we’re always trying to ascertain something whether the market is relatively cheap or relatively expensive, or whether something is undervalued or overvalued. And the sole reason we want to do that is to try and take advantage of undervalued and overvalued asset prices and basically make a profit from it.

So always keep that in mind, we don’t do this to learn economics. Of course, that’ll be part of what we do, but we’re not doing it to gain purely theoretical knowledge of economics. Our sole purpose is using that information to basically be able to buy low and sell high. And the great thing about learning to trade with the fundamentals is that it can really be applied to any asset class that we want to trade. So remember that markets don’t move in vacuums, right?

So they’re all connected and interconnected. And those connectedness often creates great correlations. And those correlations can be very effective trading tools across asset classes. So after that little bit of a rant, let’s just jump into the key fundamental factors or drivers that we need to focus on.

Now, there are a few key drivers that should always form the base of our fundamental analysis. And remember the goal is to establish whether something is cheap or expensive and because our focus is on currencies for this video, we need to understand what fundamental factors will drive the value of a currency up and down. So with this in mind, we basically have five factors we always need to evaluate.

The first one is economic performance, fiscal policy, geopolitics, intermarket analysis, and then monetary policy. Now this list isn’t written in the order of importance as the central bank actions or monetary policy is always the main driver of the currency. We need to evaluate the first four always in line with how that might affect monetary policy going forward. So looking at the first one, economic performance. That’s always the best place to start. So what is the overall state of the economy?

Now, the current economic performance and of course the expected or the projected performance are the key factors that governments as well as the central banks will use to say things like fiscal policy and monetary policy. So when assessing the overall economic performance, a good place to start is always with the big three, that’ll be your growth or your GDP, your inflation or CPI, and then of course, the labor market or employment.

So determining whether the economy is growing or shrinking, that will be your GDP determining whether the economy has stable prices or where the prices are too low, which is basically deflation or where the prices are too high and whether the overall health of the labor market is intact. So those are key points that we need to always be analyzing for the overall health of the economy.

Now, even though growth is a very important metric, inflation can often be a bigger focus point for the market. So when an economy is growing at a healthy pace, inflation should also rise at a healthy pace, which basically will bring unemployment down at a healthy pace, which is the ideal sweet spot for where the central bank wants to take the economy. Now, when growth is basically moving too fast, it basically risks prices going too high too fast, which brings recession risks as it can choke consumer spending if prices are too high.

So if growth is running hot and inflation is picking up, that usually leads to expectations of tighter monetary policy or expectations that the central bank will hike interest rates and basically perform things like quantitative tightening. Now, when the growth is too low, for example, it risks taking prices too low as well, which basically causes deflation, which also brings recession risks as it can basically force people to cut back on spending because they think that things will get cheaper as prices start to go lower.

So if growth is running very low and inflation is moving lower as well, that usually leads to expectations of looser monetary policy or basically cutting interest rates and performing things like quantitative easing.

Now looking over to fiscal policy, that also flows from the overall health of the economy where the government will increase or decrease spending, and whether they will increase or decrease things like taxes.

So a weaker economic outlook can lead to more spending and more tax cuts. And thus a booming economy often leads to the government basically increasing taxes or maybe reducing spending just as a very basic example.

So fiscal policy and other key metrics that we need to look at, obviously in the lens of what it will or how it will affect monetary policy sending to geopolitics, very important consideration especially through the lens of how the central bank will react. So elections are something we always need to keep in mind. If one candidate is more pro-business, for example, and would most likely see more fiscal policy, more stimulus tax cuts, et cetera.

That will be a positive factor for the economy and would also opt for possible tighter monetary policy. And the opposite is also true. So if a candidate that is looking to win is more softer with regards to fiscal policy, maybe introducing tax cuts, et cetera, that is bad for business. And that can of course lead to expectations of possible looser monetary policy.

Also consider that there’s other things apart from the economic performance that can affect your politics like global pandemics, military wars, trade wars, trade deals, et cetera. All those important factors that the central bank will include in their assessment of the next step of policy will be important for us to analyze.

Then of course we have intermarket analysis. So another point that’ll affect the overall fundamental bias and something that the central bank will be paying attention to is something like commodity.

So if the country is very commodity dependent, like the RBA very dependent on iron ore and coal prices or the Canadian dollar, or the BoC focus for that will be more on oil prices as CAD is obviously very dependent on oil for its economy. Those type of considerations will be important for us to keep in mind as it is something that the central bank will look at.

Now, putting all of these things together, it might feel a little bit overwhelming at sometimes when you start with fundamental analysis, but don’t be too hard on yourself. These things do take time to find your rhythm with all the nuts and bolts, putting everything together. But once you have it in place, it’s really like riding a bike, right? So the more you do it, the more comfortable you become with it. Also keep in mind that there might be times when the focus shifts away from central bank policy towards other more short term factors.

So for example, if a bank is expected to keep rights unchanged for the next, let’s say 12 or 18 months, or if the bank has already been hiking for a year and have five or six hikes already or cuts in the pocket, then one data point might not be as big of a focus point for the overall monetary policy outlook. So in terms of shorter term or sentiment drivers, that those types of things might take center stage if we have the central bank expected to leave rates unchanged for a long time or maybe have been cutting or hiking for a long time. But eventually the longer term view will come back into focus and monetary policy, of course, will be the key driver in the more medium to longer term. Now, the most important thing about all of this is how all of these points come back to the central bank, right?

So how it comes back to monetary policy. Always try and funnel all of these events, all the data, all the geopolitics, all the intermarket moves, always try and look at that through the lens of how the central bank might look at it as well. And that way, we can try and anticipate how the market will think those things will change monetary policy going forward.

So keep in mind, the market is always forward looking in nature. So they’re always trying to front run what they think the market or what they think the central bank will do next. So that’s a very important point. So consider something like inflation and interest rates, right?

So obviously for most of the major central banks, 2% is that sweet spot for where they wanna keep inflation. When we have inflation running very high, maybe above 3%, et cetera, there’s risk of overheating the economy.

That’ll obviously bring expectations of hiking of interest rates. And then when we have inflation moving lower, basically deflation, the cooling of the economy, of course, that’ll lead to expectations of lower interest rates.

And the market will always try and front run those potential moves, which is important for us as traders to keep in mind. So there’s basically three questions that we can always ask ourselves about monetary policy, about fundamental analysis, about our process.

And the first one is, is the central bank more likely to tighten or loosen monetary policy in the future? Second one, when is the central bank expected to adjust or begin adjusting policy?

And in third, how aggressively are they expected to adjust that policy? So the good news about having access to something like Forex source, of course, is that we do most of this heavy lifting for you in our analysis on a daily basis, right? So on a weekly basis, we have the fundamental drivers report that goes through all of the key drivers for the major economies.

We have the top trading opportunities report on a daily basis. We, of course, in the market insights tab, we have the current sentimental drivers which basically gives you the latest developments, the future sentiment shifts, the primary drivers for each currency. We have the dominant currency sentiment themes, we have the ongoing video commentary.

So a lot of that heavy lifting has already been done on a daily basis. So that really saves you a lot of time and basically having access to that, current things moving the currencies right now is the most important thing. Otherwise you can spend all of your time doing research and analysis and not having enough time to actually trade the predominant factors moving through the markets right now.

So keep that in mind. That’s always a good process to follow looking at these five things as the key fundamental drivers. And that should set you off on the right course for doing your fundamental analysis for currency specifically.

And of course, for doing your analysis, fundamental analysis on all of the different asset classes as well.


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