You’ve got to love the markets just for their unlimited ability to surprise.
No sooner does the sequester strike, taking a cool $85billion out of the Federal budget on Friday night, than the Dow Jones moves to new all-time highs.
And the dollar index has climbed.
This is a great example of how trying to trade fundamentals looks like a mug’s game. Surely the best information we can hope to gain from fundamentals is that “something might happen”… or even that “something big might happen”.
Beyond that, you’re just singing into the wind. Right?
For the last few years, traders have been telling us that fundamentals are dead.
But recently, there’s been a change of heart…
It looks like fundamentals are fighting back – this could be a game-changer…
Today I’d like to show you exactly which facts you need to know for the “new fundamentals”.
Plus, I’ll tell you about an easy short-cut you can use that will put the key facts right at your fingertips.
But first, the hard way…
What the traditional fundamental trader had to know
For many years, the forex markets were all about fundamental analysis – with traders needing to cram up on political and economic events that may affect prices.
To be a fundamental trader, you needed to look at economic policy, inflation, growth rates and unemployment rates. And by understanding the historic effects of political and economic events on a country’s currency, you can then hope to predict the effect that current events will have on that currency today.
Sounds like hard work, doesn’t it?
Just like any other market, the forex market is affected by supply and demand, which are themselves influenced by the relative economic strength of the currencies you’re looking at.
Therefore, when the fundamental trader looks at investing in a currency, they’ll be looking at foreign investments, GDP… and trade balance… If a country shows a deficit on its balance of trade, it is usually seen as a bad thing – especially if the deficit is growing – as money is leaving the country to pay for foreign goods.
Next the fundamental trader needs to examine current economic conditions – that means pouring through CPI, retail sales figures, durable goods orders…
A quick look on the Forex Factory economic calendar for this week shows up 70 pieces of data that forex traders should be on top of.
You can add to that any political issues that could crop up.
But that’s just the old-school stuff
These days, a fundamental trader wouldn’t flinch at a deficit – it’s more about comparing the size of a deficit (and the deficit reduction plan) with that of the next currency.
And there’s quantitative easing to take into account (or just the relative probability of QE from one country to the next).
And I haven’t even touched on the kind of currency manipulation we covered last week.
But what’s really overtaken the old-school fundamentals in recent years is risk. When traders get nervous, money pours into “safe” currencies – and traders have been a pretty nervy bunch in recent years.
So, when the US economy was tanking – traders continued to buy the dollar, as a safe currency. And, as we looked at last week, the Japanese Yen has grown and grown in strength, despite the weakness of its economy.
It’s little wonder that many fundamental traders threw in the towel!
So what’s changed?
Risk sentiment has been moving further back in traders minds recently, with positive economic data from the US… increased stability in the Eurozone… Chinese slowdown already factored into the equation…
And the result is that economic data from individual countries is starting to matter again.
So, what are the key things we should be looking at?
1. Central banks
These are the big boys who control money supply, and can cause sudden shocks if you’re not prepared for it. Central banks have an arsenal of weapons, but the main ones are asset purchases and interest rates.
Interest rate changes and policy statements will spell out what a central bank is doing or plans to do in future. However, by the time these announcements are made, a lot of the price effect is already factored into the market. So, it is useful to understand what the sentiment of a central bank is ahead of policy changes. This can be done by following meeting minutes which will give you an idea of what members are thinking. For example, with the Bank of England Monetary Policy Committee, we can see that three members voted in favour of raising asset purchases by £25bn last month, compared to just one the previous month.
2. The economy
A strong economy should always attract investment, and so should increase the demand for a currency. Clues here lie in the GDP, employment figures, retail sales and business sentiment surveys. The best place to find all this data is on www.forexfactory.com
“The money” in a country normally has a political leadership that they prefer – namely, one that will promote growth and give the most favourable business conditions.
A good example of how political events effect currency would be when the euro fell following the announcement that Silvio Berlusconi would stand for election as Italian prime minister, promising to pay back property taxes.
Balancing the technicals and fundamentals
Whether you’re a technical or a fundamental trader – it all boils down to one thing: market sentiment. That’s what we’re trying to gauge.
Personally, I base the majority of my trading decisions on technical analysis. However, we cannot afford to ignore important fundamentals.
As Dennis Gartman put it: “Think like a fundamentalist and trade like a technician.” You need to have an understanding of the fundamentals, but when you look at a chart, you then need to forget what you “think” about the price, and read what you “see” in the technicals without prejudice.