Top 7 Forex Fundamentals

Top 7 Forex Fundamentals -

Even if you are primarily a technical forex trader, understanding forex fundamentals is a MUST if you want to be successful long-term. Here are the Top 7 Forex Fundamentals that have the power to move the market significantly (50+ pips) in a short amount of time.

Forex Fundamentals 1: Employment Numbers

There are various employment numbers, but by far the most important of them is the US Non-Farm Payrolls (NFP) generally announced the first Friday of every month.

Because the USD is such a big player in the forex market, the US Non-Farm Payrolls is one of the biggest news events of all, having the potential to move the forex markets by over 100 pips in a short time.

Other employment numbers include each countries unemployment rate and numbers like jobless claims. A rise in jobless claims indicates a rise in layoffs (or an increase in unemployment).

Many of these numbers are trying to measure the same thing in different ways: the health of employment in the economy.

Higher employment indicates higher productivity, which is important for economic growth.

Related: Stocks vs Forex: Why Trade Forex?

Generally, higher payroll figures and lower unemployment rates are better for a currency. However, a lot depends on expectations.

If the numbers released are close to what is expected, then the movement in the market may not be as significant or in the direction expected. For example, if the Euro has been appreciating against the US Dollar for several months, a good (but expected) jobless claims number may not stop the USD from continuing to depreciate against the Euro.

However, if the released number is better than expected, then it is normally good for the currency (it may increase in value). If the released number is worse than expected, then it is normally bad for the currency.

Even a bad number MAY not cause a currency to depreciate much if it was expected – a lot of what happens in the forex market has to do with expectations.

Of course, employment numbers associated with various currencies heavily influence associated currency pairs – for example, Canadian employment numbers affect the USD/CAD, AUD/CAD, CAD/CHF, etc. The only main exception to this rule is employment numbers associated with the USD, which may affect non-USD currency pairs due to the strong influence of the US Dollar.

Forex Fundamentals 2: Consumer Price Index (CPI)

The Consumer Price Index (CPI) is generally used as a measure of inflation in an economy. It measures the the change in core consumer goods and services, which thereby indicates the change in consumer cost of living.

Some inflation is a good thing, whereas too much (or too little) inflation is bad. It is generally estimated that 2-3% inflation is beneficial to economic health and growth. However, an inflation number that is too low can indicate slow growth that could turn from stagnation into a recession, whereas inflation that is too high can likewise cause economic breakdown from out-of-control price increases.

Forex traders generally use the consumer price index (CPI) as an estimate of what the Central Bank of a country will do in response to inflation. The most common expected response of a Central Bank is to change interest rates.

Forex Fundamentals 3: Central Bank Interest Rates

Most countries have either a central bank or a small group of banks that control their respective currencies. Along with the government, the central bank generally plays a large role in monitoring the economic health of the country.

Interest rates are one of the primary ways that central banks control a country's level of inflation.

Also called the Fund Rate, the interest rate set by the central bank is the rate at which the central bank lends to all other banks in the country, which has a ripple effect on all other interest rates affecting consumers.

As an investor, a rate increase means you can get a higher return, whereas a rate reduction means a lower return. Likewise, as a trader, it is important to know that generally a rate increase will cause a currency to appreciate in value, whereas a rate decrease will cause the currency to depreciate in value.

However, other factors play a role in currency value, which is why a currency with a lower central bank fund rate may actually be appreciating against a currency with a higher rate.

In the US, the Federal Reserve aims to keep inflation at 2%.

If the inflation is too high then the Federal Reserve will raise interest rates (generally good for investors) in order to increase the cost of borrowing to consumers, which slows down consumer spending and thereby slows down inflation. As noted, for an investor, an interest rate increase in a country is generally ideal, assuming overall economic health, because investors can get a higher return on their money if they invest there.

Similarly, if inflation is too low, then the Federal Reserve may lower interest rates in order to stimulate consumer borrowing (now cheaper to borrow) and thereby stimulate economic activity to increase growth and inflation.

The US Dollar should appreciate in value if the Federal Reserve raises interest rates, because more investors will want US Dollars for the higher return. Conversely, if the Federal Reserves lowers interest rates, then the US Dollar will generally depreciate – but again currency value depends on many factors.

Forex Fundamentals 4: Retail Sales

Retail Sales numbers measure the sales of all consumer goods sold in the economy, which helps indicate the health of the economy. This number is important because consumer spending makes up typically about 68% of the primary measure for productivity: GDP (Gross Domestic Product).

Productivity is arguably the most important variable in economic growth, with increased productivity correlating to increased growth. So monthly Retail Sales numbers indirectly provide insight into the overall productivity, growth, and health of the economy.

Forex Fundamentals 5: Trade Balances

If you imagine that a country is a business, then the trade balance would be similar to the business' balance sheet of revenue and expenses. When the business (country) sells goods and services to consumers (other countries) it receives revenue. Likewise, when a business (country) purchases goods and services from consumers (other countries) it incurs expenses.

The difference between the sales (exports) and the purchases (imports) is the business' profit. This is essentially what the trade balance is for countries.

Obviously, a positive trade balance is better for a country just like a positive profit is better than a negative loss for a business. However, it is not uncommon for the largest and strongest economies to have a negative trade balance as is the case for the US economy. Recently, the US has had a monthly trade deficit in the negative $40 billion range.

US imports of automobiles and other consumer products is a major source of the monthly trade deficit in the United States.

In such a case, where a country has a large negative trade balance, investors may perceive a shrinking trade balance (such as a reduction to -$35 billion) as a positive sign for economic health.

Generally, a positive trade balance (or less negative) indicates increased economic growth and production.

Forex Fundamentals 6: House Price Index

The House Price Index (HPI) is used to estimate the health of the housing market, which is another method used to estimate the health of the economy as a whole. This measure is generally expressed as a percentage change in the sales of new houses.

In the US, normally a positive percentage between 0.5% and 1% is a good sign of economic growth. However, this particular index is extremely susceptible to expectations.

Even if the HPI is negative, it could be viewed as a positive sign if the HPI is better than expectations (such as -0.3% when the expectation was -0.6%).

Forex Fundamentals 7: Central Bank Speeches

Regularly scheduled throughout the year, the agencies that control monetary policy in each country have meetings to make decisions about topics like the fund rate. These meetings and the resulting announcements typically can have a huge effect on the market, even if no changes are made.

The reason why is because investors and traders are trying to "read between the lines" and determine what the central bank may decide in the future.

Typically, speakers are described as being dovish or hawkish.

Dovish means that interest rates may be lowered, or remain at their current low level, in order to allow for greater inflation and economic growth. Conversely, hawkish means that interest rates may be raised, or remain at their current high level, in order to limit excess inflation (which also slows economic growth).

Dovish is generally great for economic growth, but it is bad for investors (due to low interest rate) which means it is often a negative for the currency's value. Hawkish can be a negative for economic growth, but since excessive inflation is reduced coupled with the high interest rates, investors often prefer hawkish tendencies.

However, both the terms dovish and hawkish are extremely subjective.

You may read one article where a speaker is described as being hawkish while another article describes the same speaker as being dovish. It is important to consider the author's reasoning for saying a speaker or central bank is being hawkish or dovish.

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