The fundamental approach is one of the two basic ways of analyzing financial markets. Technical analysis is the second. However, in this article, we will be dealing only with the fundamental approach which is the use of reports and data to assess a nation’s economic worth and the value of its currency.

These reports usually detail key indicators such as interest rate, inflation, consumer and producer price indexes, and employment rate. Hence, Forex fundamental analysis is the use of macroeconomic factors in examining the value of a currency to make trading decisions.

Interest Rates

Generally, it can be taken as a rule of thumb that interest and exchange rates are positively correlated. That is, the higher a country’s interest rate, the higher the value of its currency is expected to be. Consequently, all other factors being equal, the currency should gain more strength against the currencies of other countries that offer lower national interest rates.

This is so because higher national interest rates generally tend to attract more foreign direct investments. Since foreign investors can only invest in a country in its domestic currency, there will be more demand for that currency, resulting in its increased valuation. However, this may not always be the case as national interest rates are not the sole determinant of exchange rates.

Inflation

A country’s inflation rate can have a significant impact on the value of its currency. However, it is just one of the many interrelated factors that affect exchange rates. Although the exact impact of inflation on foreign exchange rates is debatable, a high inflation rate in a country is more likely to have negative effects on its currency than positive ones.

Inflation, a quantitative measure of the constant rise in the prices of goods and services, indicates a decline in the purchasing power of currencies. Notably, governments always seek to balance interest and inflation rates as the two are closely related. For instance, low interest rates usually stimulate consumer spending and domestic economic growth.

However, a nation with a low interest rate is not an attractive destination for foreign investments. Also, increased consumer spending due to a low interest rate can lead to overspending, with demand far outstripping supply of goods and services. At this point, inflation can ensue. And this is exactly why governments always strive to balance the two.

Consumer and Producer Price Indexes

The Consumer Price and Producer Price Indexes are closely related economic elements. Both indicate changes in the prices of goods and services. However, while the Consumer Price Index (CPI) measures changes in price from the consumer’s perspective, the Producer Price Index (PPI) does so from that of the producers.

In the United States, for instance, the Bureau of Labour Statistics (BLS) collates reports on the price fluctuations of thousands of products. It then uses the information to calculate the Producer Price Index (PPI) which tracks changes in the cost of producing those goods.

Both the Consumer Price Index (CPI) and the Producer Price Index (PPI) are important to Forex traders because they are indirect measures of inflation. Hence, they have similar effects on exchange rates like it.

Employment Reports

“Why should I pay special attention to employment reports?” you might ask. Employment reports are important to Forex traders because they give hints about the current state of a nation’s economy. Consequently, they can impact the value of its currency.

For instance, a key indicator that employment reports often contain is the unemployment rate, which is the percentage of people without a job in a country’s workforce. Being a lagging indicator, however, the unemployment rate indicates what has already changed in the nation’s economy. Nevertheless, it is still responsible for significant Forex market volatility.

Importantly, it should be noted that unemployment and foreign exchange rates are negatively correlated. That is, a high unemployment rate negatively impacts the value of a country’s currency in relation to others. Conversely, a low unemployment rate signals that the country’s economy is strong, thereby increasing the desirability of its currency.

Stock Fundamental Analysis

Both stock and Forex traders use the fundamental approach. Notwithstanding the asset class to which it is applied, the underlying principles are the same. Buying the currency of a country can be thought of as buying a ‘share’ in it.

However, if you are a Forex trader who is considering venturing into stock trading, there are specificities of stock fundamental analysis that you need to learn. They include industry and company analyses.

Industry Analysis

Industry analysis is essential for every entrepreneur. Interestingly, it is an important task that stock traders undertake, too. If you want to invest in a particular company, it would help to take as the starting point the industry in which it operates. Business is dynamic and any disruption that affects a particular industry would affect its component companies, too.

Hence, investors attempt to gauge the potential opportunities and weaknesses of the industry of the company in which they seek to invest.  It gives them an overview of the past performance of the industry and its possible future scenario.

Company Analysis

For stock traders, the whole of fundamental analysis is almost equal to company analysis. When stock traders engage in company analysis, they consider both the qualitative and quantitative fundamental factors that drive the company’s operations. Hence, they evaluate its management, the demand and quality of its products and services, and its overall profitability.

Revenue growth, Asset Turnover (AT), Net Margin (NM), Return on Asset (ROE), and Return on Equity (ROE) are some of the evaluated fundamental qualitative factors. Also, stock investors examine companies’ financials such as Price/Earnings (P/E) ratio and Earnings Per Share (EPS). They do so to determine the actual worth of those companies before they put their money on them.

Conclusion

Foreign exchange rates are affected by multiple correlated economic factors. Forex fundamental analysis is the examination of those macroeconomic indicators that can impact the values of currencies. Paying special attention to them can enable you to tremendously improve your trading results.