Traders in the forex market rely on fundamental analysis and technical analysis. Technical analysis in forex tells traders that the price and charts reflect the news.
Fundamental analysis determines the intrinsic value of an investment to determine its value, rather than historical price action or market sentiment. Forex traders look at the economic conditions that affect the valuation of a nation’s currency. There are many economic indicators and private reports that can be used to evaluate forex fundamentals.
Key Takeaways
- Foreign exchange, or forex traders, rely on technical and fundamental analysis techniques that are similar to those used in the stock market.
- In forex, a fundamental analysis looks at economic conditions that affect the value of a country’s currency.
- Major economic indicators like Gross Domestic Product (GDP) and the Consumer Price Index (CPI) provide insight into the state of a country’s economy.
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What Are Economic Indicators?
Economic indicators track a country’s economic performance. Reports are released at scheduled times by a government or private organization that detail and measure different aspects of a country’s economic health.
The effects of an economic release on the forex market are comparable to how earnings reports and SEC filings affect stocks. In forex, as in the equities market, any deviation from the norm can cause large price and volume movements.
Gross Domestic Product (GDP)
A country’s GDP is considered the broadest measure of its economy and represents the total market value of all goods and services produced in a country during a given year.
The GDP figure is often considered a lagging indicator, and most traders focus on the two reports that are issued in the months before the final GDP figures: the advance report and the preliminary report. Significant revisions between these reports can cause considerable volatility. The GDP is analogous to the revenue of a publicly traded company in that they both measure internal growth.
Retail Sales
The retail sales report measures the total receipts of all retail stores in a given country. In the U.S., this data is compiled monthly by the Department of Commerce. The report is particularly useful as a timely indicator of broad consumer spending patterns and is adjusted for seasonal variables.
It can be used to predict the performance of more important lagging indicators and to assess the immediate direction of an economy. Revisions to advanced reports of retail sales can cause significant volatility.
Industrial Production
Compiled and released monthly by the Federal Reserve Bank of St. Louis in the U.S., this report shows a change in production levels of factories, mines, and utilities. It also reports “capacity utilization,” the degree to which each factory’s capacity is being used.
Traders using this indicator often pay close attention to utility production, as utilities are closely intertwined with energy costs, which in turn depend on the weather. Unexpected weather events can result in significant revisions in upcoming reports and cause volatility in the nation’s currency.
$1.17 trillion
The average daily volume of the Forex market in North America, according to an April 2024 survey by the Federal Reserve Bank of New York.
Consumer Price Index (CPI)
The monthly CPI measures changes in the prices of consumer goods across 200 different categories. It is the most widely used measure of inflation and is closely followed by not only forex traders, but also by policymakers, businesses, and consumers.
CPI readings are compiled in the United States by the Bureau of Labor Statistics and affect forex and broader financial markets, as it is one of the key metrics central banks consider when deciding on interest rates.
Using Economic Indicators
Since economic indicators gauge a country’s economic state, changes in the conditions reported directly affect the price and volume of a country’s currency. Additionally, third-party reports and technical factors can drastically affect a currency’s valuation. Traders who conduct fundamental analysis in the forex market may follow these tips:
- Keep an economic calendar that lists major economic indicators and when they are released.
- Watch future forecasts as markets move in anticipation of an upcoming report.
- Be informed which indicators capture most of the market’s attention. Such indicators are catalysts for the largest price and volume movements. For example, when inflation is high, the CPI is one of the most watched indicators.
- Know the market expectations for the data, and then pay attention to whether the expectations are met.
- Don’t overreact. Often numbers are released and then revised, and things can change quickly.
- Pay attention to data revisions, as they may be a useful tool for seeing trends and reacting accurately to future reports.
What Are the Risks of Forex Trading?
Foreign exchange, or forex trading can be profitable, but it entails risks that are not present in other markets. Unlike domestic stock trading, forex traders are also exposed to currency risk when the value of a foreign currency goes up or down. In addition, forex brokers may offer extremely high leverage, which can easily wipe out an unlucky trader if the markets move against them.
How Do Forex Traders Make Money?
Forex traders make money by betting that the value of a country’s currency will rise or drop relative to another’s.
How Many Indicators are Available to Traders?
Aside from GDP or CPI reports, many indicators can be useful to traders, like the Purchasing Managers Index (PMI), Producer Price Index (PPI), durable goods report, Employment Cost Index (ECI), and housing starts. There are also a variety of privately issued reports like the Michigan Consumer Confidence Survey.
The Bottom Line
Many economic indicators help traders evaluate forex fundamentals. Investors must look at the numbers but also understand what they mean and how they affect a nation’s economy. When properly used, these indicators can be an invaluable resource for any currency trader.
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