We begin in this chapter with an exploration of the forces that move the prices:
the fundamentals. The reader will learn why fundamentals are important to foreign
exchange (forex) traders as well as what kind of economic activity are
most important in affecting price movements. These include interest rates, interest rate
differentials, economic growth, and sentiment regarding the U.S. dollar.
WHY FUNDAMENTALS ARE IMPORTANT
In many ways, forex trading is similar to playing a game. You have an opponent (the
market). In game of chance the key feature is that everyone faces the same odds
and therefore the same level of information. In these games, no player can change
the odds.
Playing forex, however, is not a game of odds. Participants in forex trading do not
share the same amount of information. In forex, this asymmetry of information results in
advantages and disadvantages to trades. Some players have more information than the
others. In forex, information about fundamental aspects of economies does not arrive
simultaneously to all participants. The real important question is what kind of knowledge
and information can improve trading performance. The search for an edge starts with a
fundamental understanding of the nature of the forex market. Having a foundation of
knowledge in fundamentals is a first step in evolving into a winning trader.
In getting acquainted with the forex market, most people start by looking only at
price charts and price patterns. This is called technical analysis. But the study of whatmoves those charts is called fundamental analysis. The goal of Part I is to identify the
components of fundamental analysis in regard to forex and then provide a recipe for
developing your own fundamental analysis of a currency pair.
Why take time to look at forex fundamentals? Why should fundamentals matter if a
trade is done off a short-term time interval such as the 5-minute chart? The short answer
is that one cannot separate the fundamentals from the technical analysis without exposing
oneself to great distortions in understanding the forex market. Foreign exchange is
by its nature both fundamental and technical and reflect the increased globalization of
the world economy.
It is worthwhile to note the comments of the late, great Milton Friedman in a 2005
conversation with Dallas Fed president Richard Fisher:
The really remarkable thing about the world is how people cooperate together.
How somebody in China makes a little bit of your television set. Or somebody
in Malaysia produces some rubber. And that rubber is used by somebody in the
United States to put on the tip of a pencil, or in some other way. What has
happened has been an enormous expansion in the opportunities for cooperation.
(http://dallasfed.org/research/swe/2006/swe0606e.html)
Consider the following: every transaction in the world settles in a currency. Whether
it is a consumer purchase, an imported or exported item, an investment in an equity,
or even cash under the mattress, the world’s economic activity is essentially a
flow of money. What makes forex fascinating as a market and as a trading vehicle is
the fact that currencies provide an intimate linkage to the world economy. The currency
trader by putting on a currency trade becomes a participant the world economy.
The trader is participating as a speculator looking for a very short-term profit. The forex
trader is riding on a global wave. Some will surf the waves, jumping on and off; others
will stay in much longer and face the volatility. Forex trading becomes possible
because the world is constantly assessing and reassessing the value of one currency
against another. The forex currency trader is looking to tap into this stream of changing
values.
The challenge is to find the right combination of tools that can assist the trader in
finding high-probability profitable trades. In meeting this challenge, the first step is understanding
what moves currencies over time. In putting together a recipe for successful
forex trading, knowing the fundamental chemistry of forex is highly recommended. Anyone
who doubts this should simply look at daily headlines that evoke names and places
that are part of the daily consciousness of a trader. These names should be familiar to
all traders: Bernanke, Fukui, Trichet, Xiaochuan. The words and decisions of these central
bankers of the United States, the Bank of Japan, the European Central Bank, andthe Bank of China alert the trader to interest rate policy and news that affect sentiment
about the direction of the dollar. Mention the capitals Pyongdong, Baghdad, Tehran, and
they evoke emotions of fear and crises. Detect news about retail giant Wal-Mart’s sales,
and one starts anticipating a potential reaction in the currency markets. These and other
factors mix together and form the chemistry of forex, which results in shifts of sentiment
regarding the U.S. dollar. These shifts in sentiment cause price reactions and shift
the balance between buyers and sellers. Let’s look in more detail at these fundamental
factors.
the fundamentals. The reader will learn why fundamentals are important to foreign
exchange (forex) traders as well as what kind of economic activity are
most important in affecting price movements. These include interest rates, interest rate
differentials, economic growth, and sentiment regarding the U.S. dollar.
WHY FUNDAMENTALS ARE IMPORTANT
In many ways, forex trading is similar to playing a game. You have an opponent (the
market). In game of chance the key feature is that everyone faces the same odds
and therefore the same level of information. In these games, no player can change
the odds.
Playing forex, however, is not a game of odds. Participants in forex trading do not
share the same amount of information. In forex, this asymmetry of information results in
advantages and disadvantages to trades. Some players have more information than the
others. In forex, information about fundamental aspects of economies does not arrive
simultaneously to all participants. The real important question is what kind of knowledge
and information can improve trading performance. The search for an edge starts with a
fundamental understanding of the nature of the forex market. Having a foundation of
knowledge in fundamentals is a first step in evolving into a winning trader.
In getting acquainted with the forex market, most people start by looking only at
price charts and price patterns. This is called technical analysis. But the study of whatmoves those charts is called fundamental analysis. The goal of Part I is to identify the
components of fundamental analysis in regard to forex and then provide a recipe for
developing your own fundamental analysis of a currency pair.
Why take time to look at forex fundamentals? Why should fundamentals matter if a
trade is done off a short-term time interval such as the 5-minute chart? The short answer
is that one cannot separate the fundamentals from the technical analysis without exposing
oneself to great distortions in understanding the forex market. Foreign exchange is
by its nature both fundamental and technical and reflect the increased globalization of
the world economy.
It is worthwhile to note the comments of the late, great Milton Friedman in a 2005
conversation with Dallas Fed president Richard Fisher:
The really remarkable thing about the world is how people cooperate together.
How somebody in China makes a little bit of your television set. Or somebody
in Malaysia produces some rubber. And that rubber is used by somebody in the
United States to put on the tip of a pencil, or in some other way. What has
happened has been an enormous expansion in the opportunities for cooperation.
(http://dallasfed.org/research/swe/2006/swe0606e.html)
Consider the following: every transaction in the world settles in a currency. Whether
it is a consumer purchase, an imported or exported item, an investment in an equity,
or even cash under the mattress, the world’s economic activity is essentially a
flow of money. What makes forex fascinating as a market and as a trading vehicle is
the fact that currencies provide an intimate linkage to the world economy. The currency
trader by putting on a currency trade becomes a participant the world economy.
The trader is participating as a speculator looking for a very short-term profit. The forex
trader is riding on a global wave. Some will surf the waves, jumping on and off; others
will stay in much longer and face the volatility. Forex trading becomes possible
because the world is constantly assessing and reassessing the value of one currency
against another. The forex currency trader is looking to tap into this stream of changing
values.
The challenge is to find the right combination of tools that can assist the trader in
finding high-probability profitable trades. In meeting this challenge, the first step is understanding
what moves currencies over time. In putting together a recipe for successful
forex trading, knowing the fundamental chemistry of forex is highly recommended. Anyone
who doubts this should simply look at daily headlines that evoke names and places
that are part of the daily consciousness of a trader. These names should be familiar to
all traders: Bernanke, Fukui, Trichet, Xiaochuan. The words and decisions of these central
bankers of the United States, the Bank of Japan, the European Central Bank, andthe Bank of China alert the trader to interest rate policy and news that affect sentiment
about the direction of the dollar. Mention the capitals Pyongdong, Baghdad, Tehran, and
they evoke emotions of fear and crises. Detect news about retail giant Wal-Mart’s sales,
and one starts anticipating a potential reaction in the currency markets. These and other
factors mix together and form the chemistry of forex, which results in shifts of sentiment
regarding the U.S. dollar. These shifts in sentiment cause price reactions and shift
the balance between buyers and sellers. Let’s look in more detail at these fundamental
factors.
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