Back to Basics #3: What is Fundamental Analysis?

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Last week we discussed about Technical Analyses (Here & here), this week let’s talk about a different but equally important method of analysis: Fundamental Analysis.

Fundamental analysis or macro trading is a certain type of strategy, usually employed by Hedge Fund managers that look for patterns in the underlying fundamental economic data to try to predict future market trends.

In financial markets, macro analysis deals with understanding the big picture and shaping a world view as to why in certain market environments currencies rise/currencies fall and really what is the catalyst for major long-term trends.

It's Not Just About Currencies

Typically, the fundamental analysis focuses across multiple asset classes like:

  • Currencies;
  • Interest rates;
  • Global Indices;
  • Commodities

The first thing fundamental analysis should deal with is: Why currencies rise and fall in the larger trend? Why do we look at things like economic data such as GDP growth, inflation forecast and labor market trends? And why we look at things that shape the economy and shape the central bank’s monetary policies? Answering this question it will shape your bias for a given currency and what that means for essentially deciding if you want to be a buyer or a seller.

The major forces that have been driving currencies over the past several years have been the outlook on interest rates, risk sentiment and the political landscape.

Central Banks & Interest Rates

The outlook on rates is sort of a very classic type of interpretation of why currencies rise and fall because the interest rate set by the central banks is essentially the de-facto sort of benchmark return on holding a currency. The reason why traders care about interest rates is because if a central bank were to raise the interest rate the return on owning that currency raises which would make it more attractive and which will bring people to want to buy it and which, at least in theory will raise the FX exchange rate.

 

Since interest rates are one of the most important factors in the fundamental analysis, macro traders put a lot of emphases not where rates are but where are rates going and where do market expect rates to go and how those expectations line up with the reality of where rates go. This is a critical part of the fundamental analysis because where interest rates are at any given moment in time is already reflected in the market.

What the markets care about is not what’s there at the moment, but what they care about is how reality lines up with where they expect things to go. If there is a misalignment there if reality turns out not to reflect what investors expect that’s what moves currencies because investors have to readjust their positions in the market.

Conclusion

In order to succeed in utilizing fundamental analysis, you have to put in the time and the hard work in studying the fundamental macroeconomic data that drives the markets. You also need to be aware that macro trading is suitable only for the long-term trading. However, being aware of the big macro trends in the markets can also be beneficial and increase your short-term
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At 19, JT was already a stock investor and Forex trader who not only profited from the financial markets, but also managed to pay off his tertiary education in full by putting his investing skills and knowledge to the test. JT firmly believes that investment education is the best form of post-education that accords one the power to attain financial freedom, something that he wants to empower all his students with.

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