Fundamental Analysis - understanding how economic, political and social events, reports, central bank representatives' statements, etc. will influence the psychology of the participants and, implicitly, the price of a particular currency.
The fundamental factors outline the market sentiment. The overall economic picture of a state, its political and social stability, as well as the balance between its imports and exports - the trade balance - have a particular influence in shaping this sentiment.
Positive trade balance - exports > imports - high purchasing power of the national currency
Negative trade balance - exports < imports - low purchasing power of the national currency
Interest rates - what percent of your loan/deposit will you pay/get to/from bank as interest. They are set by the Central Banks, depending on the objectives of the national monetary policy - as a rule, keeping inflation under control.
Inflation - the steady rise in the prices of goods and services.
Interest rates increase → loans, spending and investments decrease → inflation is slowing down.
Interest rates decrease → loans, spending and investments increase → boost of economic growth.
Usually:
Accepted target inflation rate is 2%.
Interest Rate Differentials - comparing the interest rates of two currencies.
A big Interest Rate Differential→ the stronger currency will appreciate even more (compared to weaker one)
A small Interest Rate Differential → good sign for the weaker currency.
Hawkish central banks target high interest rates to keep inflation under control.
Dovish central banks target economic and employment rate growth, adopting moderate positions.
Information sources about fundamental factors
Consensus - the major prediction before fundamental events. Used as a reference point for assessing the impact that actual data will have.
Before important fundamental events the market volatility increases, displaying a series of risks such as sudden price changes, slippage, the risk of "being left out", higher spreads. During these periods we should be cautious and the end of the first wave of reactions after the announcement.
News can be traded directionally - based on a particular direction forecast (in agreement with consensus) or non-directional - we take into account all possible scenarios.
Pay attention to USD related news!
Market Sentiment – reflects whether there is a Buy or a Sell pressure in the Market.
It can be determined based on traded volumes – provided by the COT (Commitment of Traders Report), issued every Friday.
The report centralizes, for each participants category (Small and Large Speculators), the reportable and unreportable, long and short Future contracts concluded during the week.
Usually, the Hedging Funds capitalize on reversals while the Small and Large Speculators trade during the general trend.
If the Commercials (Hedging Funds) Buy at high volumes while the Non-Commercials (Big and Small Speculators) Sell at high volumes – sign of potential reverse.
! Not every extreme marker sentiment leads to a new High/Low.
Percentage of Buy orders = Number of Buy contracts: Total number of Buy and Sell contracts
Percentage of Sale orders = Number of Sell contracts: Total number of Buy and Sell contracts
These percentages can help us to anticipate the new Highs and Lows.
We may also identify reversal points by monitoring net trading volumes by category of contractors over a longer period, arranging them an a scale similar to an indicator's and comparing future developments with these data.