Profiting from Fundamental Analysis
Exploit the main trends by analyzing fundamental news and data
In order to be profitable in forex trading, it is not enough to be aware of the main trends, the overarching economic currents that drive trends in economic life for two reasons. One is that economic trends tend to turn to bubbles over the long term, and an understanding of long term dynamics rarely helps one in identifying when to exit a trade before the destructive stage of the bubble begins. The other is that, since we want to build positions gradually, we need to have some idea of how prices oscillate as they trend, so that we can enter a position at a favorable price, and exit, if we desire, with sizable profits. The knowledge necessary for making this type of decision is acquired through the analysis of data and news. For example, we may know, by our analysis of the cycle, and the other major factors contributing to it, that interest rates around the world will come down over the next six, twelve, eighteen months. In other words, we may be anticipating a recession, or a slowdown at the international scale. But by being aware of high frequency data, such as commidity prices, employment data, or consumer demands, we may be able to identify a particular nation where the central bank is likely to raise rates, even as this course of action goes against the powerful background trend directing policy action in all nations of the world. We can then use this divergence in local and general trends to create a new trade, where we take a counter-trend position in the short term, anticipating that the nation`s economy will, in some time, return to become in harmony with the rest of the wolrd. In our example, for instance, we`d be believing that the central bank is committing a policy error and will have to reverse course in some short time, creating an excellent opportunity for a short position on the currency.
Choose the currency pair to trade by reading the big picture, and time your trade through analysis of news and data
We can now combine the two items above to reach a general strategy that can be applied at different zoom levels, and timeframes. In order to successfully to trade any currency pair, we must understand its interaction with the global markets. What makes it appreciate? And what reduces its appeal? Is it a liquid pair, and if it is not, how sensitive is it to market shocks? How volatile is it in comparison to a benchmark (such as the S&P 500, but much better, an anchor pair such as the EURUSD)? Within the context of volatility, is it a range pair, or a trending pair? And how long do you, as the trader, intend to hold to pair?
These questions are of great importance in determining the profitability, and safety of your trade scenarios, and they can only be determined completely through fundamental analysis. Let us see give some examples.
What makes a pair appreciate/depreciate?
A commodity pair will tend to appreciate in the boom phase of the cycle, and will be even more attractive if the main export commodity is in high demand due to certain technological innovations. For example, we would anticipate copper to appreciate as the global downturn of the 70s came to an end, but with the advent of the information revolution we would be even more bullish on the commodity, and currencies of nations exporting it. In consequence, we would be willing to invest in currencies of copper exporting nations.
Is it a liquid or illiquid pair? How sensitive is it to liquidity shocks?
Both NOKUSD, and AUDUSD are carry trade currencies, and both nations export commodities (Norway has oil, while Australia produces gold, iron, and many otherraw materials.) But because Norway is a relatively small European country, with much of its economic relations focused on the Eurozone, the NOKUSD tends to be a lot less liquid than the AUDUSD pair, which is traded around the world. Similarly, the USDJPY pair is less sensitive to market shocks than the AUDJPY pair, even though both are Yen pairs, because markets regard AUD as a riskier currency (the USD is a reserve currency, and many international loans are dollar-denominated, while AUD has no such advantage.)
How volatile is the pair?
We can measure the volatility of a currency pair by comparing it to the most liquid pair of an era. At our time, EURUSD is the pair that is in greatest demand. Thus, we can compare our favored currency pair to the EURUSD to gauge the risk that we take as a function of volatility.
What kind of patterns does the pair demonstrate?
Each trader has a desired timeframe, and strategy, and will prefer to trade currency pairs that suit best to such a strategy. Understanding and analyzing the movements of currency pairs from this perspective would make long-term decision making easier, increasing our profitability, and reducing the level of uncertainty that we have to deal with during times of volatility.
Conclusions
Fundamental analysis is the most effective tool in trading currencies for a few simple reasons. It gives trader confidence that he knows what he is doing, so surviving volatility becomes a lot easier. It makes long-term planning much more efficient, and increases profitability. Better yet, by engaging in a smaller number of long-term transactions, the broker`s fee is reduced too. Although it can be somewhat more complicated and difficult to understand at times, fundamental analysis gives us the greatest clarity, perspective and decisiveness in trade decisions, and can hardly by neglected without cost, even if you desire to be a purely technical trader.
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Profiting from Fundamental Analysis
Article written by http://www.forextraders.com
The forex market is by far the most suitable investment medium for realizing the full potential of fundamental analysis. We know that currencies tend to reflect the underlying long-term trends that dominate economic activity at the macro-level. And while technical tools may tell us how something happens in the marketplace, only fundamental methods will give us to confidence to exploit it for the long term, with compounded profits. Let`s take a look at how this is done.
Adapt your trade plan to the dynamics of the era
The first step that a trader must take while planning to exploit a forex price event is defining the nature of the era that a nation`s economy is going through. As national economies across the world become strongly integrated in response to advances in the communication technologies, the correlation between economic trends in individual countries also increases, and in turn, the era, the cycle, however we define it, becomes more of a general theme across nations, depending on the level of integration with the global system as a whole. This is both an advantage, and a disadvantage for the forex trader. It means, first of all, that we can predict, on a general level, the direction of types of cuyrrencies merely on the basis of their interaction with the system as a whole, or in other words, by identifying the role that they play in the wider framework of international economics. This makes identifying and exploiting opportunities easier. But also, this means that one can never think of a truely safe currency that will be totally isolated from trends on a global scale, and will provide the perfect hedging options to protect one`s protfolio from sudden, and general shocks that may influence nations across the board. In sum, in a globalized world, no hedge is a real hedge, and your only protection against speculative losses is lower leverage.
Examine and understand the cycle
Beyond understanding the general characteristics of an era, to create successful and feasible fundamenal scenarios we must examine and understand the business cycle, the phase it is going through, and the role of politics and technology in creating them. Just by understanding the cycle, and creating a solid trading strategy on the basis of that understanding we may able to trade currencies with great results on the longer term. Inquisitive traders will hardly fail to notice the years-long uptrend of the Euro after the 2001 recession, for example, or the rise of the dollar during the dot.com bubble years, or the recent phase of USD strength, each of which lasted for many years, and created low risk opportunities for those who were aware of the causes behind them, and confident enough to trade them.
In another example, we can add that it is nearly impossible to carry trade any currency pair over the long term without an understanding of what leads to the appreciation of carry pairs. The cause, of course, is to be sought in the boom-bust cycle, and the liquidity cycle as global interest rate policies become synchronized, with generalized implications for all. One of the most important consequences of the dynamics creating economic cycles, for example, relates to the role played by speculative capital. At times of tight credit (which implies general political, and social unrest, and economic uncertainty), speculators are unlikely to create bubbles in the real economy. We do not expect speculative capital, or banks (which may be playing this role), to finance a lot of new factories, or to create lots of new trading corporations at a time when there is great uncertainty with regard to the profitability of any long term endeavor. Thus, any bubbles that arise are destroyed quickly (as adverse conditions do not allow the spreading of positive rumors, barring fraud). On the other hand, when the world economy is going through a growth phase, with good employment prospects, and ample credit available to investors, good news are everywhere. At such times, it is hard to find any asset class that does not somehow constitute a bubble. A perfect example of this was experienced during the 2007-2008 economic collapse when almost every major asset class depreciated violently, as multiple bubbles burst.
What use this is knowledge? In short, during busts assets tend to be undervalued, and during boom times, just about everything is overvalued (except for the fear factor). By being aware of the phase of the cycle, forex traders can adjust leverage, risk, and the average lifetime of a trade with greater safety and confidence.