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Fundamental analysis

Forex traders often use a variety of economic data to determine where a given country ’ s economy and currency may be headed next. This data may include: Gross Domestic Product (GDP), imports, exports, employment, unemployment, growth, debt and many other factors. Collectively, these factors are often referred to as the fundamentals. Therefore, fundamental analysis refers to the analysis of any data, as well as the actual price patterns of the currency itself. The price patterns frequently impact on the value of the currency on the Forex market.

Supply and Demand

The value of currencies responds to changes in supply and demand. For example, if the demand for US Dollars rises, so will the value of the Dollar (USD). Likewise, if there are too many Dollars available on the market their value will drop along with the demand.

Forex Currency Pairs

Currencies on Forex are traded in pairs – one currency ’ s value either drops or rises in comparison to another. Currencies are represented by a three-letter abbreviation such as USD, JPY or EUR. In the currency pair, the first currency is called the base currency and the trailing is called the quote currency. The price at any given moment shows how much of the quote currency is needed to equal one unit of the leading or base currency.

For example: When the EUR/USD pair is priced at 1.5000, this means that it takes 1.5 US Dollars to exchange for 1 Euro. If the Euro rises in value, then the EUR/USD price will also rise as more US Dollars are needed to buy each Euro. Likewise, if the Euro drops in value, then the price of the EUR/USD pair will also drop as fewer US Dollars are now required to equal each Euro.

The value of the leading or base Forex currency is not the only factor in determining the value of a particular currency pair. Any change in the value of the trailing or quote currency also affects this relationship.

So, in the same example, if the US Dollar now rises in value, then the EUR/USD pair would drop as fewer Dollars are now needed to buy each Euro. If the US Dollar drops in value, then the EUR/USD price would rise, as more US Dollars are now required to equal each Euro.

Interest Rates

Another key factor that influences the value of a given currency is the constantly changing interest rate. Interest rates are determined by the central bank of a particular country.

For example: If the Federal Reserve (Fed) in the United States lowers its interest rate, then the value of the US Dollar usually drops, causing the EUR/USD pair to rise. If the Fed raises interest rates, then the US Dollar will typically go up as well, causing the EUR/USD to drop.

Central banks are always caught in a delicate balancing act. If a country ’ s currency gets too strong, its exports become too expensive and other countries may look elsewhere.

Higher interest rates also tend to attract more foreign investments, which is why the currency of that country frequently goes up with the interest rates. Meanwhile, cheaper interest rates tend to stimulate lending inside the country and therefore economic growth.

Macroeconomic Indicators

The most important indicator is the GDP report. Basically, the GDP is the broadest measure of the state of an economy. The GDP is an aggregate monetary value of all the goods and services produced by the entire economy during a quarter (excluding international activity). The key number to look at is the GDP growth rate. Generally, deviations from the normal level can prove to be rather influential. Growth above this level is often thought to be unsustainable and a precursor to high inflation, while growth below this range (and especially negative growth) means that the economy is running slowly, which can lead to increased unemployment and lower spending. It is worth noting that each initial GDP report will be revised twice before the final figure is settled upon: the advance report is followed by the preliminary report about a month later and a final report a month after that. Significant revisions to the advance number can cause additional ripples on the markets.

Do not confuse Gross Domestic Product with Gross National Product (GNP). GDP includes only goods and services produced within the geographic boundaries of a country, regardless of the producer’s nationality. GNP does not include goods and services produced by foreign enterprises but does include goods and services produced by national firms operating in foreign countries. For example, if a U.S. firm was operating a chain of stores in France, the goods and services produced by those stores would not be included in the GDP but would be included in the GNP. As the global economy grows, the difference in GDP and GNP is decreasing for developed countries like the U.S. But for smaller, developing countries, the difference can be substantial.