WHAT MOVES THE MARKETS? (An Introduction to Fundamental Analysis) What we’ll cover: - How some economic events and pieces of information move the forex market - How to make sense of the forex market through fundamentals - How to use economic calendars LET’S GET GOING. ANALYSIS OF THE MARKET IS AN ESSENTIAL PART OF BEING A TRADER AS IT WILL HELP YOU IDENTIFY THE BEST PLACES TO ENTER AND EXIT TRADES. WITHOUT A PROPER ANALYSIS STRATEGY IN PLACE FOREX TRADING CAN EASILY BECOME A GAME OF RUSSIAN ROULETTE (THE REAL RUSSIAN ROULETTE, NOT THE CASINO GAME). IN THIS MODULE WE WILL BE FOCUSING ON FUNDAMENTAL ANALYSIS. TECHNICAL ANALYSIS WILL BE COVERED IN A LATER MODULE. WHAT MOVES THE MARKETS? 2 3.1 INTRODUCTION: WHY DO I NEED TO ANALYSE THE MARKET? To become a more skilled trader, you’ll need to develop two sets of skills. 1) Fundamental analysis 2) Technical analysis Two very different skill sets, yet equally as important to learn. WHY DO I NEED TO ANALYSE THE MARKET? 3.2 WHAT ARE MARKET FUNDAMENTALS? Fundamentals can include macro-economic factors such as a country’s: • • • • • • Inflation rate; Interest rates; GDP figures; Employment figures; Balance of trade; Geopolitical Stability. The strength of a currency is determined by supply and demand. The market fundamentals listed above have an impact on the supply and demand for a currency and therefore impact how a currency is valued. “A MARKET FUNDAMENTAL is a piece of specific data or an event that can have an impact on the price of a Fundamental analysis includes the study of economic data that could potentially affect a currency’s value. When you are applying fundamental analysis you are basically looking at a country in the same way you would look at a company and its currency as you look at a company share. You use this data to project whether the currency will gain in value or if it will lose value. This will help you decide when to buy or sell a currency. financial asset”. BEFORE WE GET THERE LET US ESTABLISH AN UNDERSTANDING OF HOW THESE FUNDAMENTALS INDIVIDUALLY AFFECT THE VALUE OF A CURRENCY. WHAT MOVES THE MARKETS? 3 3.3 FACTORS THAT INFLUENCE CURRENCY EXCHANGE RATES Different factors can affect currency price movement. It is good to have a basic understanding of how and why these factors impact forex. We have included the most important factors which can affect the valuation of a currency. With each factor we will look at how it can result in a currency appreciating or depreciating. QUICK DEFINITION Appreciation: increase in value of a currency Depreciation: decrease in value of a currency E XAMPLE WHAT MOVES THE MARKETS? - Suppose the USA and South Africa both have an interest rate of 5%. You would get a similar return if you put savings in a US bank or SA bank. - However, if the US increased interest rates to 5.5% then you would get a higher return by saving in a US bank. Therefore, SA investors may sell rands and buy dollars so that they can gain more interest from their savings. - This increased demand for dollars will push up the value of the dollar against the rand. 4 INTEREST RATES Interest rates have a huge impact on the demand for a currency. If country A has a higher interest rate than country B, an Investor who deposits money into country A’s banks will get a higher return than he would by depositing into country B’s banks. It will become attractive to invest money in country A, and demand for country A’s currency will rise. For international investors, profitability comes from moving money between different countries with different interest rates. They generally move money from low interest rate to higher interest rate bearing countries. Higher interest rates Lower interest rate => Money flows INTO countries with higher interest rates => Demand for these currencies increases => Currencies appreciate. => Money flows OUT OF the country with lower interest rates => Demand for these currencies decreases => Currencies depreciates. If you’re anticipating an increase in the interest rate of a particular country, then this could present an opportunity to go long on (buy) the country’s currency. If you anticipate that a country is about to reduce interest rates then this could present an opportunity to go short (sell). E XAMPLE WHAT MOVES THE MARKETS? - US interest rates are of great interest to most global traders. Any changes in US interest rates are announced after the Federal Open Market Committee (FOMC). This FOMC Rate announcement is probably the most influential event for the financial markets. Any policy changes that impact the US Federal Reserve bank interest rates are announced after the FOMC meeting. - This announcement happens about 8 times a year and is worth keeping on your economic calendar. 5 INFLATION Inflation indicates how the prices of domestic goods and services are increasing in a particular country. Therefore, the inflation figure can give you an indication of whether the purchasing power of a currency is increasing or decreasing. Higher inflation means that, over time, 1 unit of the country’s currency can buy less and the currency will depreciate. A country with a consistently lower inflation rate is one that can buy more and more over time. As a result the currency will appreciate. Lower inflation rates Higher inflation rates => Greater demand for the country’s goods and services => greater demand for the currency => Currencies appreciates. => Lower demand for the country’s goods and services => lower demand for the currency => Curreny depreciates. If you are anticipating that inflation data for a country is going to show an increase in the inflation rate, this could present an opportunity to go short on (sell) that currency. If you anticipate that a country is about to report an increased inflation rate then this could present an opportunity to go long (buy). WHAT MOVES THE MARKETS? 6 BALANCE OF TRADEHOW The trade balance total is the value of exported goods minus the value of imported goods. A positive value indicates a trade surplus, while a negative value indicates a trade deficit. Countries that have a trade surplus attract more capital inflows compared to countries with trade deficits. The demand for that local currency increases, resulting in the appreciation of the local currency. The opposite will be true for a country with a trade deficit. An increase in Trade Balance => increase in exports against imports => greater demand for the currency => Curreny appreciates. Decrease in Trade Balance => decrease in export sales against imports => lesser demand for the currency => Currency depreciates. If you believe that balance of trade data for a country is going to show an increase in the trade surplus, this could present an opportunity to go long on (buy) that currency. If you anticipate that a country is about to report a growing trade deficit then this could present an opportunity to go short (sell). WHAT MOVES THE MARKETS? 7 EMPLOYMENT DATA Employment data is a good indicator of the level of prosperity in a country’s economy. In fact, it’s so important that a lot of countries release updates on a weekly or monthly basis. An increase in the levels of employment usually indicates that the economy is growing as there are more people who can and are able to spend money on goods and services. A decrease in the employment rate generally implies a weakening economy. In most cases the value of a currency increases as the number of unemployed people decreases. Increase in Employment figures => increase in consumer spending => better economic performance => Curreny appreciates. Decrease in Employment figures => decline in consumer spending => poor economic performance => Currency depreciates. If you are anticipating that employment data for a country is going to be positive i.e. show an increase in number of jobs, then this could present an opportunity to go long on (buy) that currency. If you anticipate that a country is about to report a decrease in employment figures then currency will most likely weaken and this could present an opportunity to go short (sell). E XAMPLE WHAT MOVES THE MARKETS? - The US Non-Farm Payroll (NFP) is usually the most closely watched employment data. - It measures the number of paid part-time or full-time workers in the US, excluding the farming sector. It is the most comprehensive measure of US job creation. It is released the first Friday of each month at 15:30 (our time). - If you trade USD, there might be opportunities to trade when this data is released. 8 GROSS DOMESTIC PRODUCT (GDP) The gross domestic product of a country is a measure of all of the finished goods and services that a country generated during a given period. GDP gives the best measure of health of a country’s economy. The GDP figure is calculated by taking into consideration: • • • • the total expenses of government, money spent by business, private consumption, exports of the country. An increase in the GDP figure indicates positive economic growth. Foreign investors are attracted towards countries with an increasingly strong GDP. It leads to better valuation of the country’s currency because more and more investor capital flows into to the country, increasing demand. Higher GDP => Money flows INTO countries with higher GDP => Increased demand for those currencies => Curreny appreciates. Lower GDP => Money flows OUT OF the countries with lower GDP => Reduced demand for those currencies => Currency depreciates. WHAT MOVES THE MARKETS? 9 GEOPOLITICAL STABILITY AND OTHER NEWS EVENTS We’ve looked at the economic fundamentals that affect currency. Now let’s look at the political and geopolitical fundamentals that can have an impact on the value of a currency. The confidence that the global market places in government or leadership of individual countries has an impact on the value of currencies. Anything that undermines the confidence in a country’s leadership has a negative impact on the value of its currency. Hence, countries with stable governments generally tend to enjoy better economic growth, which results in currency appreciation. Government instability causes a loss of foreign investor confidence and negatively impacts economic growth. E XAMPLE WHAT MOVES THE MARKETS? - An example could include the events that unfolded after President Jacob Zuma’s dismissal of Finance Minister Nhlanhla Nene Wednesday 9 December 2015. - This severely undermined global confidence in South Africa’s leadership and resulted in global investors ditching the rand. This massive sell-off of the rand resulted in the currency plummeting to what was then a record low of R15.37 to the USD. 10 Here is a quick summary of how some of the key fundamentals impact a currency: FOR TRADERS, events like civil wars, coups, elections, shifts in monetary policy, drought or even natural disasters can create very lucrative opportunities to trade. Although these can result in large price movements, the key is having an understanding of how the price will react to the news and making a trade in the correct direction. Fundamental factor Good for a currency Bad for a currency Interest rates Higher interest rates Lower interest rates Inflation rates Lower inflation Higher Inflation Employment figures Higher employement Lower employment balance of Trade Increase in Trade Surplus Growing Trade deficit Geopolitical stability Higher investor confidence Lower investor Confidence GDP Increase in GDP Decrease in GDP How fundamental market data can affect currency exchange rates Gathering and making sense of all this information is just one part of a trader’s daily routine. The particular economic events you pay attention to will be mainly determined by the currency pairs you trade. HAVING A FIRM GRASP OF THIS ASPECT OF TRADING CAN GO A LONG WAY IN IMPROVING YOUR CHANCES OF BEING A SUCCESSFUL TRADER. WHAT MOVES THE MARKETS? 11 YOU HAVE REACHED THE END OF THE THIRD MODULE. C ONGRATULATIONS!
