Fundamental Analysis - Part 1

What is Fundamental Analysis?

Fundamental analysis is the study of all underlying elements that influence the economy status of a particular nation. Fundamental analysis in Forex is very similar to the analysis of the performance of a company. When analyzing a company, we usually look at their financial ratios, company policies, operating environment, etc. While in Forex, we look at the economic indicators, government policies and societal factors that influence the exchange rate of a nation. Those fundamental factors are the market driver that influences the exchange rate. Fundamental analysis is a very effective way to forecast the economic condition of a nation in long term basis. It can't give you an immediate indication of the exchange rate movement when you trade live.

Macro-Economics and Forex

The measure of a nation's economy status is basically quantified by its trade flow. It is a measure of how much money in-flow or money out-flow of a nation. When a nation imports more than it exports, the nation buys more and sells less. This results more money flowing out from a nation than the money flowing into a nation. This is called trade deficit. When a nation exports more than it imports, the nation sells more and buys less. This results more money flowing into a nation than the money flowing out from a nation. This is called trade surplus.

Price quoted in Forex market represents the strength of one currency over another. If a currency of a nation is weakening, trading with this nation is cheaper. Therefore, it actually favors a nation that exports more. Under this situation, money is flowing out from this nation and the economy of this nation goes toward inflation and vice versa. Therefore, a nation's exchange rate decreases during trade deficit but increases during trade surplus. Trade deficit and trade surplus are the main factor that results in the fluctuation of a nation's economic and financial data.

Economic and financial data are the indicators that a Forex trader should monitor to analyze the pulse of the economy health of a nation. Economic data are usually collected and generated by government and some private sectors periodically. The economic data can have an impact to exchange rate movement when it is being released to public. Some major economic indicators are listed below:

• Gross Domestics Produce (GDP)
• Industrial Production
• Producer Price Index
• Consumer Price Index
• Non-Farm Payroll
• Unemployment Rate

Forex basics: Usage of Leverage

Forex brokers usually provide their customers with a leverage of up to 200:1. It is a mechanism that allows traders to trade on borrowed capital without investing tens of thousands of dollar to make profit. It is critical for a trader to know exactly how it works and how to use it.

There are three types of lot size, i.e. standard lot, mini lot and micro lot.

• Standard lot = 100,000 units of base currency
• Mini lot = 10,000 units of base currency
• Micro lot = 1,000 units of base currency

The profit/lose of every pip movement in price for each lot size are shown below.

• Standard lot = $10
  
• Mini lot = $1
• Micro lot = $0.1

From the number shown above, you should realize that slight fluctuation in the exchange rate can make you significant amount of profit, it can also cause you to lose you capital fairly quickly when you trade with higher leverage.

The scenario can be explained with examples below. It is assumed that you have $5,000 as your capital initially.

100:1 Leverage
In this case, you open a standard lot trade with 100:1 leverage. Your required capital is $100,000/100=$1,000. Assume the exchange rate went in another direction than what you expected. Since every pip movement costs $10 thus it takes 100 pips to wipe out your capital completely. When you close your position after your capital is wiped out completely, you left with $5,000-$1,000=$4,000. That is 80% of your initial capital and you lose 20% of your capital in just one trade.

200:1 Leverage
In this case, you open a standard lot trade with 200:1 leverage. Your required capital is $100,000/200=$500. Assume the exchange rate went in another direction than what you expected. Since every pip movement costs $10 thus it takes 50 pips to wipe out your capital completely. When you close your position after your capital is wiped out completely, you left with $5,000-$500=$4,500. That is 90% of your initial capital and you lose 10% of your capital in just one trade.

Therefore, it requires wisdom when trade with leverage. Leverage can be useful and earns you great profit when used carefully. On the other hand, leverage can cost you all your capital when used recklessly. The higher the leverage the higher the risk is involved. It is recommended for a beginner to trade with lower leverage, i.e. smaller lot initially. A trader only move to higher leverage when he/she is equipped with proper skills and enough experience.