Fundamental analysis is about analysing the strengths which influence the economy, such as production capacity, consumer trust, job opportunities etc. Fundamental analysis can help to find the cause of price fluctuations, and can also (help to) predict future price fluctuations.
Fundamental analysis is indispensable for a good Binary Option strategy. If you look at our economic calendar you will see an extensive array of figures that are important to the financial markets. The most importantindicators are explained in our information centre.
Traders always closely watch the fundamental themes of important countries, the four most important fundamental themes are:
This is self-evident. The strength of a national currency is primarily determined by the strength of the economy in which it functions. And just as the quarterly/annual figures of a company say a lot about the economic health of that company, the quarterly/annual figures of a country say a lot about the economic health of that country. The financial markets therefore focus primarily on the economic clout of national economies.
Economies develop in a cyclical movement, i.e. in an upward or downward trend. The peaks and troughs of those trends often change position in the short term or the long term. This is to nobody’s advantage, so the government has the objective of keeping control of the cyclical movement of its economy: fewer high peaks and fewer deep troughs.
An important tool for this is the interest rate. Specifically, the interest Central Banks (such as ‘De Nederlandsche Bank’ , ‘Deutsche Bank’, ‘Bank of England’) charge to commercial banks when they want to borrow money from the Central Bank. This is important because if it becomes more expensive for banks to get extra money, it will also become more expensive for investors to get money, as a result of which growth will decline. Conversely, investments will increase when it becomes cheaper for banks to borrow money from the Central Bank.
Imagine the amount of goods the US buys from the Eurozone is 100 billion dollars more than what it sells. To be able to buy these goods the Americans will need euros. Therefore they are actually purchasing 100 billion euros. Their Trade Deficit ensures that the euro increases in value compared to the Dollar.
In reality it is often much more complex (for example, what of American companies in the Eurozone which export those goods to the US) but it is important to understand that the value of a currency can decrease if the deficit in the trade balance of a country increases.
The financial markets are influenced by politics, and mainly by the stability of the politics of the country in question. Understandably so, since “trading” in most financial markets is in national economies, not in individual companies.
Political instability can harm economic growth and therefore also certain related markets.
Why economic news is important
Economic indicators give all sorts of hints about the condition of a country’s economy. Furthermore, it gives insight into the needs of national and international companies.
Is the interest over a currency being lowered by the Central Bank? Then it will become cheaper to borrow money and therefore cheaper to invest. The money market becomes broader which means that the exchange rate of the currency concerned usually will decrease vis-a-vis other currencies.
Governments and large companies ‘create’ the (economic) news. This news has actual value and speculative value. The actual value is determined by the response of companies and governments, the speculative value is determined by the traders. Traders, large and small, therefore also respond to the news because:
a) It says something about how multinationals (and smaller companies) have operated over the last period and how they will probably operate over the following period.
A simple example: has the GNP of a country increased in comparison to other countries? Then there will be a demand for the currency of that country, since every company would like to invest in a country that is doing well. The value of the currency vis-a-vis other currencies will probably increase.
b) It says something about the probable future conduct of the government/authorities to which the news applies.
A simple example: Has inflation in the Eurozone increased to 5%? Chances are the ECB will increase the interest so that the money market shrinks and inflation will therefore (hopefully) decrease. The value of currency will then (probably) increase.
c) Other traders large and small can then also respond.
This is maybe the most important reason for the reaction of traders to news: the expectation that the other traders will also respond. It is free-for-all, and if all the others decide to buy euros and to sell dollars then you had better join them…..
Virtually every successful trader therefore closely keeps up with the news!