Fundamental analysis means measurement of a financial asset value in connection with political and economic processes and events.
There is a connection between financial-economic, political, and economic events that take place in individual countries and blocks of countries as well as in the whole world and currency exchange rates and stock prices.This connection can be studied using the fundamental analysis.
Fundamental analysis is the most difficult part of economic analysis of the market. It is more difficult than any other one, because under different conditions the same factors can have different impact on the market and major factors can become quite insignificant. In addition to certain initial official rules, such analysis requires practical experience.
In practice, methods of fundamental analysis are used by market traders in combination with other types of market analysis and allow evaluation of general history and perspectives of trading instrument rates based on interdependence between fundamental, economic and other factors and standard response of trading markets to them.
Fundamental analysis takes into consideration the following factors:
- Political crises;
- Much publicized resignations and Cabinet of Ministers reshuffles;
- Imprudent statements in press;
- Release of economic indicators for countries and blocks of countries;
- International conflicts;
- Awaited elections;
- Natural disasters (force-majeure).
All events considered in the fundamental analysis can be planned or unplanned. All planned events (release of economic indicators, planned speeches given by the Heads of the Cabinets or other influential officials, release of the election results etc.) are published in the economic calendar. Unplanned events include any force-majeure (fire, natural disasters, acts of terrorism etc.). Furthermore, in the course of fundamental analysis politics means redistribution of public good and resources based on economics-related reasons.
Market response to any unplanned event as assessed in the context of fundamental analysis is unpredictable and depends on a specific situation. The history has seen political events that changed dollar exchange rate against other currencies by 200 points within a very short period of time. (For example Caribbean Sea oil spill, the capture of Saddam Hussein by U.S. forces, Hurricane Katrina and so on).
Nevertheless, it is possible to predict further movements of the trading instrument rate upon the planned release of economic indicators. For example, changes in statistical data on the unemployment rate will have a clear impact on the national currency exchange rate. At the same time, market response to the release of economic indicators follows a certain mechanism.
In your work we recommend using the economic calendar of events that you can find at www.forexpeoples.com.
Release of economic indicators from leading countries influences currency exchange rates to a different extent. According to their importance, such indicators can be divided into the following groups:
1. Very important
- Gross-National Product
- Trade deficit
- Payment deficit
- Inflation indices (Consumer Price Index [CPI] and Wholesale Price Index [WPI])
- Unemployment and employment data
- Money supply data (М4-М0 monetary aggregates)
- Official discount rates
- Parliamentary, congressional, or senatorial elections. Presidential elections (currency is influenced by election promises made by the candidates and historical preferences of the parties).
2. Moderately important
The exchange rate can sometimes react to this group of news. Everything depends on the specific situation on the market.
- Size of retail sales
- Size of housing starts
- Size of factory orders and durable goods orders
- Industrial production index
- Producer price index [PPI]
- Consumer price index [CPI]
- Futures exchange rates
- Deposit rates
- Stock indices (Nikkey, Dow Jones, DAX etc.). Growth of these indices shows that national economics is in good state, and increases the demand for national currency of this country.
- Dynamics of prices for government securities (T-bills, T-bonds).
Influence of the indicator on the currency exchange rate is shown in the Table below./p>
|Indicator||Change of indicator||Change in national currency|
|Inflation indices: Consumer Price Index [CPI] and Wholesale Price Index [WPI]||Growth||Drop|
|Official discount rates (repo, Lombard etc.)||Growth||Growth|
|Gross-National Product (GNP)||Growth||Growth|
|Money supply data (М4, М3, М2, М1, М0)||Growth||Drop|
|Presidential or parliamentary elections||Growth||-|
|Size of retail sales||Growth||Growth|
|Size of orders||Growth||Growth|
|Producer price index||Growth||Drop|
|Industrial production index||Growth||Growth|
|Forward exchange rate||-||-|
|Futures exchange rate||-||-|
|Effective exchange rate||-||-|
|Stock indices (DJI, NIKKEY, DAX, FTSE)||Growth||Growth|
|Prices of government securities (T-bills, T-bonds)||Growth||Growth|
Release of fundamental data, as we have mentioned above, is a planned event, and according to existing international agreements, countries with leading economics are obliged to publish their projected and actual macroeconomic indicators. Bear in mind that the market takes projected indicators immediatelyinto consideration, and there is a possibility of a rapid market response if an economic indicator released is significantly different from that previously projected or when indicators from the previous periods are reconsidered. Predicting market response is challenging and requires practical experience.
Data from the fundamental analysis can and should be taken into consideration when developing trading strategies but only in combination with technical analysis data. Taking trading decisions based solely on fundamental data or shortly before the release of major fundamental data is unacceptable as the market response cannot be predicted. Besides, there is a practice where a planned release of an economic indicator leads to the re-evaluation of the previously published data on this indicator, which often reverses an overall response of the financial market. Let’s take a look at the example below.
The number of initial unemployment claims in the USA (data published every two weeks) at the moment of release was 418,000. The previous figure was 515,000 and the projected figure was 452,000. The number of initial unemployment claims filed is clearly less than expected, which indicates that economic situation has improved. The market would respond by rapid growth of the US dollar exchange rate against all other currencies by a certain amount (in practice, up to 50 points). Two minutes after the US dollar exchange rate has already started to move, a revision of the previous two-week-old indicator may be published, and the figure of 515,000 may be revised to 468,000. Then, the projected figure is little different from that released two weeks ago in terms of the absolute value, and the reverse reaction would follow returning the exchange rate to its initial level within a short period of time (approx. 10 minutes) or, alternatively, provoking a reverse movement. Commonly, a sharp increase in oppositely directed volatility of currency exchange rates may occur for a short period of time when a group of major macroeconomic indicators are released, followed by the price returning to the same level existing before the release of indicators.
Bear in mind that different macroeconomic indicators influence price movements of financial instruments based on different time intervals. For example, the ratio between discount ratesof State Central Banks is an indicator influencing global trends in the movement of currency rate ratio. The higher the discount rate of the State Central Bank is, the more profitable the investments in this currency are (however, consider inflation expectations). When the Central Bank changes the discount rate level, investors re-evaluate profitability of investments in this currency and refocus their interest towards another financial instrument. A similar situation exists with respect to the assessment of the market value of temporary CFDs for shares of the largest world holdings. The fundamental indicator is the profitability level of stocks (%) over the previous financial period. For assessment of investment profitability in the short term, investors use profitability reports over shorter (up to one month) time periods.
Methods of fundamental analysis are discussed in an easy-to-understand manner in the recommended literature.