There are basically two approaches to operate the forex market: fundamental analysis or technical analysis
Technical Analysis: studying the behavior of prices and indicators to try to predict future price behavior.
Fundamental Analysis: Study the underlying economic, social and political move supply and demand for instruments.
What is the best approach?
There has always been a strong debate which approach is better, sometimes technical analysts predict the price behavior accurately but some fundamental analysts have better performance. The truth is that no single answer to this question. I dare say that the answer has to do much with each operator, many feel better off operating based on technical analysis while others are more comfortable doing transactions based on fundamental analysis.
If you are a short term trader, then surely prefer the technical approach, because this approach focuses on the analysis of short-term price. While fundamental changes are taking longer to be reflected in the graphs.
If you are a long term trader, then probably the fundamental approach is more suitable for your needs because changes in supply and demand take longer to balance.
Today, many operators use two approaches to get a better view of all changes in the instruments operated.
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Tags: Lesson 03
Section II: What Moves the Forex Market?
The currency movements, like any other financial market, are driven by two main forces: supply and demand.
Consider again our example of used cars in a small town. At first only going to be a few sellers. When the population grows, more and more people need cars vain to meet their needs, pushing up demand for cars. At this point the demand for cars is larger than the number of cars offered, pushing up prices. At this point people will realize it is a good business selling used cars inserting the market to sell cars. At this point more and more cars will be available for sale, supply pushing up car. At some point, the supply of cars will be larger than the demand for cars, car dealers if not lower their prices, they will not be able to sell all your inventory, thus lowering prices.
The same applies to foreign exchange, when a currency rises in value, demand is still greater than supply. When the dollar declines in value, the offer is still larger than its demand.
What factors influence supply and demand for the currency?
The two most important factors influencing the price of a currency are:
1. Capital Flows
2. Trade flow
These two components constitute what we call as balance of payments. The main purpose of the BOP is to quantify the demand and supply of a currency of a country in a given period.
Balance of payments Capital Flows + = trade flow
A negative balance of payments indicates that the capital leaving the country is greater than the capital entering the country (the demand is small).
A positive balance of payments means that capital entering the economy is greater than the capital this coming (increased domestic demand for currency).
Theoretically, a balance of payments equal to zero represents the “true” value of a currency.
The flow of capital is the net amount of money (buying and selling) through equity investments.
The flow of capital may be divided into: physical flow and investment flow
Physical flow. This flow happens when foreign entities sell their local currency and buy foreign currency for foreign direct investment (to make acquisitions, etc.). When the value of such investments increases reflects a positive state of the economy where capital is invested.
Investment flow. These are investments in global markets, fixed income and variable (Forex, stocks, government notes, etc.).
The commercial flow measuring exports and net imports of a country. These two components constitute what we call Current Account.
Countries that have a positive current account (exports greater than imports) is more prone to devalue its currency. In this way consumers perceive lowest foreign currency to purchase goods or services to foreigners (can buy more goods and services). A good example of this is Japan.
Countries that have a negative current account (imports greater than exports) are more likely to appreciate its currency because they need to sell more expensive local currency to buy foreign goods and services at lower cost. An example of this case is the United States.
Purchasing Power Parity (PPP – Purchasing Power Parity)
This theory explains that changes in exchange rates are determined by the relative prices of a basket of similar goods across countries. In other words, the price ratio of lasa baskets with similar assets should be equal or similar to the exchange rate.
For example, if a computer in Australia costs AU $ 1,500 and the same computer in the United States costs $ 1,200, according to the PPP, the exchange rate AUD / USD would be 1.2500 (1.500 / 1.200 = 1.2500).
If the exchange rate AUD / USD was 1.3000 (or above 1.2500, according to this theory the value of the exchange rate must depreciate up to 1.2500. On the other hand, if the exchange rate was 1.0500, this would tend to appreciate up to 1.2500.
These examples are illustrative, in the real world applies to a basket of goods and not just a good.
The biggest weakness of this theory is that it assumes no transaction costs related to trade in these goods (taxes, fees, etc.). Other disadvantage is that they do not consider other factors that may influence the exchange rate (as the interest rate).
The modern monetary theories of capital market including the theory of PPP thinking that these transactions are less transaction costs.
Theory of Interest Rate
This theory states that the differentials in interest rates undermine the positive and negative changes from one currency against another, so that there can be no arbitration (opportunities without risk).
For example, if the interest rate in Australia is 5.5% and the interest rate the U.S. is 3.5% then the AUD should be appreciated that in this way has no arbitrage opportunities.
There are other theories that attempt to explain the value of a currency pair. But like all theories, are based on assumptions that may or may not in real life.
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Tags: Lesson 03
Section III: Fundamental by Country
In this section we give a small glimpse into the economy of each country’s large foreign exchange as well as its most important basic study for each of them.
Note however, this list may not reflect what happens in the real world, we base our analysis on probabilities, and as in all probability, is likely to break down. This analysis is informational only.
European Economic and Monetary Union (EMU) – EUR
Quick Facts Eurozone Economy
– The EMU consists of 16 member countries: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Slovenia, Spain, Sweden, Norway and the UK. Although the United Kingdom, Sweden and Norway have entered the last facet of the EMU which adopted the euro as its currency, continue to use their own currency.
– The euro zone is called the group of countries that have adopted the euro as their currency.
The Eurozone GDP and so
Source: International Monetary Fund (2006)
– According to the International Monetary Fund, if the European Union (EU) were a country, would be the only country with a GDP above U.S. with 14.5 trillion USD.
– Apart from the common currency, the Euro Area share a common monetary policy dictated by the European Central Bank (ECB). The ECB was established under strict rules for each of the members, and its main rules are:
– Price stability
– Low Inflation (1.5% below the average of the three best numbers of members)
– Gaps under
– The importance of EUR has increased significantly as more countries in the world change their reserves from USD to EUR
Leading Economic Indicators for the EMU
Here is a list of important economic indicators that tend to have a high impact on the forex market.
Notice of Interest Rate
The interest rate is a measure of the cost of money. The European Central Bank interest rate used as a tool to meet their most important objectives: inflation, growth and price stability.
When the ECB lowers interest rates, the euro tends to depreciate against other currencies because lower yields (eg, investors sell their euros to buy other currencies with higher yields, thus increasing the supply, this causes low price EUR).
When the ECB raises interest rates, the euro tends to appreciate against other currencies since it generates higher yields (eg investors sell their local currency to buy euros, this increases the demand for Euros and finally makes its price).
NOTE: As we know, the Euro Area consists of several countries, and each has its own data on GDP, inflation, etc.. While it is important to have an idea of the overall performance of the EU, for the following indicators, it is more important to monitor the performance of 3 or 4 most important countries in the EU (refer to the table of GDP above).
Gross Domestic Product (GDP or by its initials in English GDP) of Germany and the U.S.
EU’s GDP is the value of products and services produced within the territorial limits of the EU. A good GDP reflects a healthy economy.
A number of GDP indicates that the economy is growing and the euro tend to appreciate against other currencies.
A bad GDP number indicates that the economy is declining and the euro tends to lose value against other currencies.
Fuel for Thought 1 – What is a good or bad a number of fundamental announcement? In the GDP we saw (as we do with other indicators): a good number tends to appreciate the value of the Euro, What does “good”? A value above zero? Or maybe, a number above 50? Analyze it and try to reach a conclusion, once you think you have the answer refer to the section of the summary.
Harmonized Consumer Price Index (Consumer Price Index Harmonic)
The HCPI is what the U.S. used as a measure of inflation and price stability. As we explained above, the ECB has certain rules for its members, and this is one of the most important, a country can not deviate from 1.5% of the average of the countries best assessed.
Usually for the EU:
With a low of HCPI, the euro tends to gain value against other currencies.
With a high number of HCPI, the euro tends to lose value against other currencies.
Data from German and U.S. Unemployment
The unemployment data is always one of the best indicators of the health of an economy in any country. When the numbers are good usually reflect good health.
Usually for the EU:
A good number tends to appreciate the Euro against other currencies.
A wrong number tends to depreciate the euro against other currencies.
The Eurozone trade balance measures the amount of services and products purchased (imports) against those sold to other countries (exports). The eurozone’s trade balance is divided into two components: Intra-and extra-Eurozone Eurozone, Intra-Eurozone regards trade with EU member countries and the Extra-eurozone trade concerns with the rest of the world. Usually the Extra-eurozone have much impact on the currency market.
A number of trade balance, usually tends to appreciate the value of the Euro
A bad trade balance numbers, usually tends to depreciate the value of the Euro.
Most investors focus on the trade balance of Germany, as this is the main economy of the Eurozone.
Industrial production in Germany and the U.S.
The Eurozone industrial production measures the total output of manufacturing industry and the energy sector. Many times this indicator is used as a proxy for GDP of any country.
With a number the Euro will gain value against other pairs
With a bad number the Euro is going to lose value against other pairs.
Most traders and investors focus on the data from Germany for being the main economy of the EU.
ANOTHER NOTE: For the following indicators, it is good focus on the performance of Germany.
IFO Business Climate Survey (Germany)
The IFO survey is one of the most important sentiment indicators for the Eurozone. This survey asks 7,000 firms in Germany: what are the conditions they perceive in the present and future business conditions. It is an index where the level 100 is the center line between good fats conditions (above 100) and poor (below 100).
A good number (better than expected) tends to appreciate the value of the Euro against other currencies.
A bad number (worse than expected) tends to depreciate the value of the Euro against other pairs.
ZEW Survey (Germany)
This is a survey of experts from across Europe about his vision of Germany’s most important indicators: Inflation, growth, stock market, cambo rates for a period of 6 months. Also ask for their views on current macroeconomic conditions.
A bad number, makes the EUR lose value against other pairs
A good number, makes the wins EUR value against other pairs.
What is the difference between IFO and ZEW surveys?
The IFO survey is applied to business owners and businesses while the ZEW is applied to experts in the field.
Bonus 10 Years of Germany
Long-term roles (government) are always a good indicator of future expectations of any country. In fact, if you make an inquiry, you will see that very few developing countries have papers of 10 years (because very few investors willing to invest at the level of uncertainty).
In this case, the bond of 10 years is a very good indicator of the expectations of the Euro, as compared to the 10-year bond U.S.:
If the German bond rate is higher, and the differential increases: it represents a bullish sentiment EUR
If the German bond rate is higher, and the differential decreases: it represents a bearish sentiment of EUR
United States – USD
Quick Facts U.S. Economy
– Currently U.S. is the world’s largest economy with a nominal GDP of 13.25 trillion USD, 3 times larger than its nearest competitor.
– U.S. has a very large deficit (ie they are the most important trading partner for most countries).
– According to the BIS, the USD is involved in the 89% of currency transactions.
– The Federal Reserve (or EDF, U.S. central bank) has two main objectives:
– Price stability
– Steady growth
– The USD is perceived as one of the strongest currencies and reliable in the world, as a result many countries (mostly developing) fixed their currencies to the USD.
U.S. Leading Economic Indicators for
Non-Farm Payrolls – NFP (Unemployment U.S.)
The NFP is probably in the top 3 of the indicators that move the market more.
The NFP shows the number of jobs created in the economy in a given month (jobs outside the government sector and agriculture). It is one of the best indicators of market forces work, and as we know, the job market is always followed as an important diagnostic of the overall economy.
A strong number indicates a strong economy therefore expect an appreciation of the USD.
A low number indicates a weak economy, so expect a depreciation of USD.
This report is published the first Friday of each month.
As already mentioned, interest rates are a measure of the cost of money. Central banks use interest rates as a tool to meet their objectives.
An increase in U.S. interest rates typically increase the demand for USD, investors sell their local currency to buy USD to take advantage of improved performance by increasing its demand and hence the value of the USD.
A cut in U.S. interest rates typically drop in demand for USD, investors will sell USD to exchange for other currencies to generate better returns, it increases the supply of USD, decreasing its value.
When there is no change in interest rates can be interpreted as both feeling bullish or bearish depending on circumstances. No change after a period where it went down continuously, is perceived as a bass player and after a period of gains, as bullish sentiment.
This report is announced 8 times a year.
This indicator measures exports and net imports of U.S. goods and services. This is the trade flow component of the balance of payments, which measures the demand for and supply of a country (as explained above).
It is important to note that U.S. has a negative trade balance with almost all the countries.
In a good number, the U.S. dollar tends to appreciate
In a bad number, the U.S. dollar tends to depreciate
This report is published every two months (mid-month).
Consumer Price Index (CPI)
This index measures changes in the price of a basket of basic goods, products and services (inflation). The aim of this indicator is to measure price changes, leaving out the changes in the quality of goods and services.
If the CPI rises, the purchasing power of a currency low, having a negative impact to the USD
If the CPI decreases, the purchasing power of money rises, making a positive difference to the USD.
This report appears commonly in the second week of each month.
Another related indicator, the Core CPI, which measures the same, but excludes food and energy related products, the more volatile components of the CPI. Thus, it has more stability in the measurement of price changes.
Thinking 3 – Is there a number of inflation for all countries?
Consumer Confidence Index
The CCI is a survey of 5,000 consumers, about how they perceive the conditions of the economy, business climate and what they expect in the future. Shows how confident are consumers in a given month.
A number of CCI indicates a good economy, positively affecting the USD.
A bad number of CCI indicates a bad economy, negatively affecting the USD.
This report is published near the end of each month.
Retail sales are an indicator of consumer spending. It measures sales of retail stores (including durable and nondurable goods), but excludes services (the major disadvantage of this indicator).
A good number indicates favorable economic conditions, so the USD tends to gain value.
A bad number indicates unfavorable economic conditions, therefore the USD tends to lose value.
This report appears in the middle of each month.
Gross Domestic Product (GDP)
Measure the amount of goods and services (total production) produced within the U.S. territorial limits. The GDP includes consumption, private investment, government spending and exports minus imports.
The most important component of this announcement is the changes (in GDP) of the current issue of the month, against the same month last year.
A good number indicates a strong economy and the U.S. dollar tends to appreciate against other currencies.
A bad number indicates a weak economy and the U.S. dollar tends to depreciate against other currencies.
ISM Manufacturing Index
The ISM is another survey of business executives and ask them about their vision for future business conditions. This indicator is important because it is the first indicator that changes after a period of recession or continued growth.
The range of values of the ISM is 50, where values above 50 signify an “expansion” and values below 50 mean “contraction” or negative expectations for the near future.
FOMC Minutes (EDF)
The minutes of the FOMC (Federal Open Market Committee) give reasons on the monetary policy decision (three weeks after the decision taken).
Investors usually focus on the key elements of how the Federal Reserve sees economic conditions and their expectations of future general reviews of other issues such as markets, inflation, etc..
Market reaction to the minutes of the EDF varies, since information is already discounted, but when they give evidence of a vision not so clear market and that there may be changes in interest rates can have a major impact on the market .
Japan – JPY
Quick Facts Japan’s economy
– Japan is the second largest economy in the world with a nominal DGP 4.4 trillion USD.
– Japan is one of the largest exporting countries in the world. A large percentage of GDP is attributed to exports (around 15%).
– The Bank of Japan (BOJ) is responsible for managing Japanese monetary policy. The BOJ is an active participant in the foreign exchange market. It is well known that when the USD / JPY is approaching the values of 100.00, the BOJ tends to intervene to defend the value and push the market up. Significantly, Japan is a net exporter, so they should have a coin “cheap” to foreign buyers perceive a relative abaratmiento their products and services.
– Although the finance minister of Japan does not dictate monetary policy further, even have some influence on the exchange rate.
Leading Economic Indicators for Japan
The Bank of Japan is responsible for monetary policy in Japan. Currently, the seven major currencies, Japan is the country with the lowest interest rate. The BOJ board once a month to announce possible changes in monetary policy and vision of the economy.
An increase in interest rate tends to appreciate the JPY
A decrease in interest rate tends to depreciate the JPY
Gross Domestic Product (GDP)
The GDP is the sum of all goods and services produced in Japan.
A number often means that the JPY gain value
A bad number often means that the JPY will lose value
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Like other surveys of sentiment, the Tankan survey is applied to companies and ask them how they see economic conditions (including business conditions).
This report is very important for foreign investors, and for BJ because it gives a picture of current economic conditions and the future. This helps investors to make investment decisions and determine the BOJ monetary policy.
A positive number means a good view of the economy (good for the JPY), while a negative number indicates poor vision.
A better than expected number usually helps the JPY
Fewer than expected usually hurts the JPY.
Trade Balance (including freight)
The trade balance measures the difference between exports and imports. As we know, Japan is a net exporter, then the higher the number, the better for its economy.
A positive number indicates a surplus, while a negative number indicates a deficit.
A better than expected number often means that the JPY gain value
A worse than expected number often means that the JPY will lose value
When we speak of goods (heading indicator), we refer to a similar indicator but only takes into account tangible as well as those of the automotive and electronics (two of the most important industries in Japan).
Employment Status in Japan
This report is an analysis of current conditions and future employment sector in Japan. As always, labor is always a very good indicator of overall performance of the economy.
The report of the employment situation in Japan unusually incorporates other data such as consumption, increase or reduction of wages, inflation, and others.
With a number, the JPY tends to gain value.
With a bad number, the JPY tends to lose value.
Minutes of the BOJ Policy
This report is usually published one month after the announcement of monetary policy. Clearly explains why increased, decreased or left unchanged the interest rates.
Traders and investors focus on key elements that can give them information about future monetary policy decisions and their vision of the current situation and future markets.
United Kingdom – GBP
Quick Facts UK Economy
– The United Kingdom (UK) is the 5th in the world economy with a nominal GDP of 2.3 trillion.
– Like other developed countries in the world, UK is a country oriented towards the service economy (mostly financial services: insurance, banking, etc.).
– UK has a close relationship with the eurozone, since exports and imports between them are about 50% of total UK trade balance.
– The Bank of England (BoE) is responsible for monetary policy in UK. The main objective is to maintain price stability (inflation at a comfortable level).
– There has been a controversial debate about whether UK should join the eurozone (the countries that adopt the EUR as currency). Arguments against: the current policies have done well in the new global economy, will not have full control of monetary policy if they join, arguments against: The power of the ECB would increase dramatically.
– The Pound Sterling (GBP) is among the most liquid currencies in the world. Given its high interest rate, traders and investors are much interested in this coin in operations of “carry trade” (to earn interest), even when other currencies with higher interest rates.
Important Economic Indicators UK
The BoE has meetings every month to announce its decision on interest rates. Currently, the GBP is the best option to “carry trades” (though there are other pairs with higher interest rate), this liquidity. The two most commonly used for this is the GBP / JPY. For this reason, operators and investors pay close attention to this announcement.
In an increase in interest rates, the GBP is commonly seen.
In a decrease in interest rates, the GBP is usually depreciate.
When there is no change in interest rate can be as bullish or bearish sentiment depending on the circumstances.
Gross Domestic Product (GDP)
The GDP shows the overall growth of the UK economy.
In a good number, £ tends to gain value.
On a bad number, £ tends to lose value.
The trade balance measures the difference between exports and imports of the UK. The UK’s main trading partner the eurozone, but by country, U.S. is still the leading partner.
In a number of GBP tends to move upward.
In the GBP wrong number tends to move downward.
Another important announcement is related Non-EU Trade Balance, which measures the ratio of exports and imports with countries outside the Eurozone.
Consumer Price Index (CPI)
The CPI is the main component of inflation. This is how many traders and investors measure inflation and therefore the increase / decrease in purchasing power of the GBP.
For the UK, usually:
A low number tends to increase the value of GBP
A high number tends to decrease the value of GBP
Another measure of the CPI for the UK Core CPI measures the price change itself but excludes two of its most volatile components: food and energy.
In the minutes of the BoE, policy makers share their vision and why they decided to change / no change in interest rate.
Whenever investors and operators focus on the view that policymakers have about future economic conditions, because it gave the notice of the interest rate. They also try to find evidence of whether a future plan to increase or decrease interest rates in the next posting.
For example, if you mention “the mortgage market is in a clear expansion” may create inflationary pressures, what you can do to increase interest rates at its next meeting.
Canada – CAD
Fast facts Canadian Economy
– Canada is currently the eighth largest economy in the world with a nominal GDP valued at 1.3 trillion dollars.
– Canada is a country dependent on trade with U.S., which imports about three quarters of Canadian exports.
– The Canadian dollar has a very close relationship with gold and oil.
– The Edict of Canada (BoC) is responsible for monetary policy in Canada. The main objective of BoC is price stability. Changes in monetary policy can be made at any time as people meet almost every day.
Leading Economic Indicators for Canada
As in other countries, the announcement of interest rates for Canada is of major importance for its currency.
Typically an increase in interest rate increases the demand for CAD making the value increase. While a cut in interest rates reduces the demand for CAD decreasing its value.