Fundamental Analysis is simply the process of identifying and understanding the "factual reasons" why the market is moving in the direction that it is currently moving within the overall trend. This is in contrast to simply identifying that a trend or price move has already happened. Identifying that a market has already had a price move is the job of Technical Analysis which is all backward-looking. Understanding why a particular currency or market is moving is the job of fundamental analysis which is forward-looking and allows you to use this information to try and predict where prices might go in the near future.

Fundamental Analysis is an extremely underserved subject when it comes to retail traders and how they obtain their trading knowledge. In this Wiki, we will explore all the various aspects of fundamental analysis and how you can apply that to your own trading for improved performance.

This Wiki is a part of our Essential Forex Trading Guide. Be sure to check that out HERE.

Introduction to Fundamental Analysis

The Basics of Fundamental Analysis

Fundamental Analysis goes far beyond a simple Technical Analysis approach which is what the typical retail trader will use to make their trading decisions. Understanding Fundamental Analysis will give you more conviction because you can have confidence that you are trading the real reasons why the market is moving rather than simply guessing by using some variation of chart pattern or indicator to make your trading decisions. In this Wiki, we will explore The Basics of Fundamental Analysis including:

You can access the main Wiki for The Basics of Fundamental Analysis HERE.

Objections to Fundamental Analysis

There are many Traders that are opposed to the concept of Fundamental Analysis. There are various reasons for this but what we will do in this Wiki is point out a few of the most popular objections and then provide some context on why they may not be well-founded objections including:

You can access the main Wiki for Objections to Fundamental Analysis HERE.

Institutional and Retail Traders

There is a big difference in the way that a retail trader approaches the Forex or any other financial market from how a professional institutional trader will go about navigating them. In the following Wiki, we will explore concepts such as:

You can access the main Wiki for Institutional and Retail Traders HERE.

Fundamental Supply and Demand

When discussing fundamental analysis there are some core principles that we need to be aware of. Supply and demand are at the heart of fundamental moves in all markets including Forex. In the following Wiki we will explore:

You can access the main Wiki for Fundamental Supply and Demand HERE.

Sentiment Analysis Overview from a Fundamental Perspective

We have a large Wiki on Sentiment Analysis HERE. Here we will do a short explanation of Sentiment Analysis.

The other most common driver of fundamental information is something called sentiment. We have already mentioned sentiment a few times now but up to this point we have not provided a definition of what sentiment actually is. Let's try and break that down now.

Let’s first think of fundamentals as the big "Macro Picture" of the health of an economy. If the particular economy is performing well and interest rates are rising then we would expect the currency of that nation to move higher over the long run. People want to invest in growing and stable economies that are performing well so this means that they will need to buy the local currency of that economy in order to invest in it. This is the most basic picture we can come up with for what fundamentals are.

Well, we know that currency prices just don’t go up in a straight line. It would be nice but that’s not the reality, unfortunately. Even though the big picture fundamental outlook may be overall positive there will be many days where the price actually goes down against the fundamental trend. In these times this means that the sentiment of the day has turned negative and forced price to be temporarily out of line with the big picture fundamentals.

Sentiment, in its most basic form, is the "Mood" of the market right now in the "Current" trading session. It’s similar to fundamentals except it lasts for much shorter periods of time. Sentiment can be in line with the fundamentals but it can also move price in the opposite direction of the fundamentals. The interesting thing about sentiment is that it can last anywhere from a few seconds to many weeks depending on how strong that sentiment is.

The importance of this aspect of supply and demand cannot be underestimated. Sentiment is so important that you will spend most of your time trying to identify the current sentiment for your trading opportunities. This is especially true if you are a shorter-term trader such as a day trader. If you are a day trader you will need to be in tune with how the market is feeling all day while you are trading.

Day traders will always want to keep the big picture fundamentals in the back of their minds, but for their biggest concern is what the market is thinking right now so that they can jump in and hopefully make some pips in the current trading session.

The very best trades happen are when the current sentiment is in line with the big picture fundamentals. These are the easiest trades because you have the power of the longer-term investors using the fundamentals and the shorter-term hedge fund traders using the sentiment all pushing the price together in the same direction. This is when you can make a lot of pips very quickly with trades that never try to go against you. This is one of the most important concepts traders should learn.

The very best trades look like the following:

If fundamentals + and sentiment + then buy all day long at good buy points.
If fundamentals – and sentiment – then sell/go short all day long at good sell points.

These are the type of trades that tend to last longer and move more in terms of pips or price. These are the trades that can make you a lot of money if you know how to identify the long-term fundamentals combined with the sentiment of the day properly.

Good trades look like the following:

If fundamentals are "Positive" and sentiment is "Negative" you have 2 options:

Allow the negative sentiment to bring the price back to where it makes fundamental sense to start buying again.
Trade the negative sentiment short against the positive fundamentals. This is where knowing how strong sentiment is will help you make some profitable trades against the big-picture fundamentals.

If fundamentals are "Negative" and sentiment is "Positive" you have 2 options:

Allow the positive sentiment to bring the price back to where it makes fundamental sense to start selling again.
Trade the positive sentiment long against the positive fundamentals. This is where knowing how strong sentiment is will help you make some profitable trades against the big-picture fundamentals.

At its most extreme, virtually nothing will stop a market until its participants have been fully satisfied. The markets are simply too large for one entity, authority, or even group of authorities to move prices in a direction that the markets don’t appear to want. Five billion dollars of transactions would represent a serious intervention by major a Central bank but would only represent less than 1% of the daily FX volume in the London trading session alone. But, when all of the big players agree that price should be moving in a particular direction this can lead to some fantastic trading opportunities with major upside potential for your trading account.

In later Wikis, we will expand on the concept of sentiment and give you the tools and strategies you need to trade with sentiment effectively. But for now, we just want you to understand that fundamentals that you determine by Fundamental Analysis are the big macro picture of what is going on in an economy and sentiment that you determine by Sentiment Analysis is the mood or the market right now in the current trading session. Sentiment is caused by fundamental economic data. Economic data releases and market-moving information that could come in many forms which we will discuss in other Wikis.

Exchange Rates

Exchange rates are an important aspect of understanding the full spectrum of fundamental analysis which is why we created a separate Wiki devoted entirely to Exchange rates. In the following Wiki, we will explore:

The main page for Exchange rates is found here: Exchange rates

Money Supply

We have a separate Wiki on Money Supply so please click on the links to take you to those specific Wikis to obtain this information.

The main page for Money Supply is found here: Money Supply.

Intermaket Analysis

To get a good grip on financial trading we need to take a few minutes out to look at something called "Intermarket Analysis" and how various asset classes and markets relate to each other. In the following Wiki on Intermaket Analysis we will cover subjects such as:

The main Wiki on Intermaket Analysis can be found HERE.

Advanced Fundamental Analysis

Fundamentals and Sentiment

You may recall that the fundamentals, particularly for FX trading, tend to revolve around the Central banks of each nation and the expectations of the market for what that bank will do next with its interest rate policies. The Central banks use economic indicators to determine the state of the economy and then implement the various tools they have at their disposal. They do this with the hopes of improving the indicators they deem important to keep the economy stable and in line with their policy mandates.

To explain this effectively we have to break the concepts of this analysis down into two distinct parts:

Fundamentals: The first part is the underlying fundamentals that we talked quite a lot about in previous sections. Fundamentals are the big macro picture for the economy being measured. For example, if you are trading the Australian Dollar then you need to understand the economic situation of Australia and what the central bank of Australia is concerned with.
Sentiment: What we haven’t looked at too much are the things that are driving the price right this moment in the here and now. This is called sentiment and is the most important thing you need to concern yourself with if you are considering becoming or are a day trader.

Therefore, we have two core elements that we must be in tune with at all times; the underlying fundamentals and the ever-changing sentiment. This is an extremely important distinction to make so make sure that you have your thinking cap on as you go through this section.

The simplest way to understand the difference between fundamentals and sentiment is to imagine that the fundamentals are the big picture. This big picture is things that don’t change very often and are the things that are driving prices over weeks and months. Sentiment, on the other hand, are the short-term things that the market participants are obsessing over that are driving prices over hours and days in the current session and beyond.

Of course, sentiment can take over in the short term and move the price against the big picture fundamental trend. However, as long as the core principles remain in play the trend will typically resume at some point when the sentiment wares off and fades away from the market's memory.

The market tends to have a short-term memory when it comes to sentiment. This means that the sentiment must be very strong to drive prices for more than a couple of days. It's pretty common for the market to get really concerned with a specific news item and move prices hard in one trading session only to completely reverse that move the next session because there is some new piece of information that the market is focussing on instead.

Understanding that the sentiment can be with or against the big picture fundamentals is key. But the best trades will always be when the current sentiment is in line with the big picture fundamentals. This is because this situation will cause the most number of market participants to trade in the same direction at the same time. However, it's also key to understand that you can make a lot of pips when the sentiment is opposite the fundamentals because the market tends to forget about the fundamentals when there is a reason to think differently.

Understanding these two concepts and how they work provides us with the foundations for identifying various trading opportunities throughout the trading day. For example, some traders use the short-term sentiment as an opportunity to trade the longer-term trend at a much more attractive price. This means that these traders wait for a situation when the sentiment is actually opposite to that of the fundamental trend. This causes prices to correct in the short term setting up nice opportunities to get in the fundamental trend at a better price. At the same time, other traders may take advantage of the counter-trend sentiment and trade in line with it to make a quick profit.

As we have already seen, fundamentals are very important to successful trading but there are other core areas that must be developed if a trader is to become successful for the long run; Fundamental Analysis, Sentiment Analysis, Technical Analysis, Risk Management, and Trading psychology. The goal should be to get yourself to a point where you are proficient in all these areas so that you can achieve your goals.

One of the core things that most traders will likely need to improve is something called "Conviction". Conviction simply means having confidence in your trading. Traders use conviction to determine how good a possible trade is and how likely it is for that trade to yield a profit. With time and practice your conviction levels will naturally increase making your trading comfortable and seem like second nature.

If you have a high level of conviction in a trade based on all the things that you understand to be true then generally your chance of success is much higher. If you combine this with your own personal research for a specific opportunity then you have a chance at increasing your conviction level.

Traders that do not pay attention to their conviction levels, or simply don’t know how to increase their conviction levels, have very little chance of success. You must constantly be aware of your conviction, measure it, and control it in order to achieve a high level of success. Keep this in mind while researching a trade to determine both the underlying fundamentals and the short-term sentiment because your conviction level will directly influence your level of Trading psychology while you are in a position. The more factual reasons you can find to support a position, the more comfortable you will feel overall because you will know that you have done all you could to give yourself the best chance of success.

Central Banks

Central Banks are so important to the Forex market and all other financial markets that we have devoted an entire in-depth Wiki to all things Central Banks. In the following Wiki on Central Banks we will explore:

Introduction to Central Banks A Brief History of Central Banks Central Banks and Interest Rates Overview of what Central Banks do Monetary Policy and Money Supply Central Bank Monetary Policy Tools Hawks and Doves Major Central Banks

The main Wiki page for Central Banks is found here: Central Banks

Please refer to the Wiki for further information on Economic Cycles.

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