A Step-by-step Guide to Fundamental Analysis of the Currency Market

This guide will give you a step-by-step planning mechanism with help of which you will be able to analyze the worldwide economic environment and make a decision of best currency to perform trading.

Step 1: Studying the Macroeconomic age
You must create a good analytical structure in mind in order to earn money and to make this structure well, it is necessary to pay attention to the basis. This involves understanding the macroeconomics at a worldwide level. Doing the basis studies very accurate is important because it helps making a good filtered data for choosing the best currency pairs out of the existing ones to the minor details. While carrying out this process, cyclical dynamics, monetary sector and other indicators need to be examined well. The past decisions pattern of monetary sector helps analyzing and predicting the future possibilities. This is the reason past data has to be kept in mind in order to take decision for future market possibilities. The first step is simple and straightforward as during a boom phase volatility drops and liquidity rises globally and during a bust phase volatility rises and liquidity falls. Another important thing to do is to keep the noise data isolated from the main data which may lead you to incorrect assumptions based on media or political basis and will cause failure of correct data.

Decide on the phase of the cycle
It is very important to determine the global economic cycle’s phase. The traders can take information from worldwide default rates, surveys on bank loans of leading economies and their accumulated international reserve. Even though these indicators are second-tier, because they give the signal of phases late, still using the information they provide changing phase of economic cycle of global scale can be determined. However, these indicators are safe because these data are confirmed with the industrial production fall, high rate of unemployment and other such factors which are visible in the later phase.

Examine technological innovations, political environment, emerging market fundamentals

Once the cycle’s phase is decided, next step is to conclude the factors that can raise the productivity and lead to non-inflationary period of economic growth globally. If the emerging economies expose themselves to the usage of new technology which is used in the developed economies, they will create a new industrial growth foundation which will lead to increased productivity and will result in non-inflationary growth. For example, adopting the new technologies like mass production, air travel, Internet etc will result in high productivity rate without inflammation if the rest of the factors are constant. Further details on this topic are discussed in the chapter of fundamental analysis.

Step 2- Studying the interest rate policies of the leading global powers
With reference to the past behavior, you can study the basis of the policies of key central banks like the ECB, the Federal Reserve and the Bank of Japan. We have taken factors like the policy biases, legal mandates, independence etc of these major banks in our study. By understanding the policy biases, you can have a good idea about the money supply growth which in turn will help you decide various factors like growth potentials in emerging markets, volatility of stock market and many more.

Step 3-Examining the interest rate differentials of nations

With the help of results of unemployment statistics, output gap and capital expenditure and taking in view that the main focus of time markets is the interest rate differences of currencies result in forming an opinion with the same track as the interest rates of central bank are. Studying and understanding output gap and unemployment statistics is very important. When an economy’s capacity constraints increase and unemployment decreases, there is a shortage in the labor market which creates wage pressure and all of this will finally result in increased prices and inflation. In order to avoid this inflation, the central bank will increase rates and maintain it at high level until the economy cools down with signs of increased unemployment and decreased capacity constraints. In the same way, a trader can form an opinion about the interest rates predictable values using these values.

Compare the balance of payments of the currencies
You can think a nation’s balance of payments similar to a company’s balance sheet. If the balance of payments shows healthy results, the nation’s currency will also be strong in economic turmoil times. You can study the nation’s balance sheets in terms of capital and current account situation. It is important to know whether the external position of nation is maintained by asset sales and bank deposits or long-term developments like reverse accumulation and direct investment. As discussed in the previous details, traders can take a good understanding of payment dynamics and the balance.