Fundamental Analysis

Introduction:

In trading, nothing is based purely on luck. Successful traders carry out a series of analysis in order to make reasoned trade decisions. Technical Analysis and Fundamental Analysis, are the most popular analytical tools used by traders for decades.

Fundamental analysis is basically a way of looking at the financial market via the analysis of economic, social and political forces that may affect the demand and supply of a particular currency pair or asset.

Demand and supply are key economic principles. Anyone with some basic economic is aware that these two forces are what determine the price of an asset.

Trading through fundamental analysis is very often referred to as trading the news. The forces of demand and supply are widely used as indicators of where the price of currencies and assets could be headed.

Support & Resistance levels

For example, the chart above depicts the demand and supply for the US Dollar. If people start demanding more US Dollar (demand shift to the right) the price will increase and as a result, the quantity will also increase. Conversely, if there was a rise in supply (supply shift to the right) quantity would increase but the price would fall.

Micro and Macro-economic information such as GDP, interest rates, monetary policies and employment statistics are also to be considered since they tend to have major effects.

4 main steps of fundamental analysis

1. Top-down analysis

The first step is to study macroeconomic factors as they help set the basis for a trader’s analysis. Keeping track of past data has great relevance as this can help predict future directions of the market. The data are combined and then you have to work your way downwards to narrow and refine your search to include only those currencies and assets that present a profit potential.

2. Bottom-up analysis

Bottom up is the opposite of the top-down approach. Here, currency pairs and assets are analysed working from bottom to the top and combining macroeconomic information. The bottom-up approach primarily attempts to identify those assets and currencies which have high potential.

3. Study the global environment

The first two steps provide a general study of the different currencies and assets. In the third step, you attempt to go into more details. GDP, interest rates, monetary policies and employment statistics are analyzed to have an insight on money growth supply which consequently guides traders to decide variables such as emerging market growth, stock market volatility and interest rates expectations.

4. The decision

In this fourth and last step, you finally decide what asset or currency you want to trade and for how long you want to hold your positions.

The truth about fundamental analysis is that there is no one method fits all. However, most traders prefer to use the top-down approach.

Support & Resistance levels

Being a truly academic exercise, fundamental analysis can be very complex. But if you can understand its different principles, you can identify your greatest potential for gain.

In the next lessons, you learn about the different aspects of fundamental analysis and how it can be helpful in your trades.