Welcome everyone,

I am often asked if I pay attention to the market fundamentals when I trade, but before I weigh in on fundamentals let me give you some background on it.

Those trading in the foreign-exchange market (forex) rely on the same two basic forms of analysis that are used in the stock market:  fundamental analysis and technical analysis.  The uses of technical analysis in forex are much the same: price is assumed to reflect all news, and the charts are the objects of analysis.  But unlike companies, countries have no balance sheets, so how can fundamental analysis be conducted on a currency?

Since fundamental analysis is about looking at the intrinsic value of an investment, its application in forex entails looking at the economic conditions that affect the valuation of a nation's currency.  Here we look at some of the major fundamental factors that play a role in the movement of a currency.
 
Economic indicators are reports released by the government or a private organization that detail a country's economic performance.  Economic reports are the means by which a country's economic health is directly measured, but do remember that a great deal of factors and policies will affect a nation's economic performance.

These reports are released at scheduled times, providing the market with an indication of whether a nation's economy has improved or declined.  The effects of these reports are comparable to how earnings reports, SEC filings and other releases may affect securities.  In forex, as in the stock market, any deviation from the norm can cause large price and volume movements.

You may recognize some of these economic reports, such as the unemployment numbers, which are well publicized. Others, like housing stats, receive little coverage. However, each indicator serves a particular purpose, and can be useful.  Here we outline four major reports, some of which are comparable to particular fundamental indicators used by equity investors:

The Gross Domestic Product (GDP):  The GDP is considered the broadest measure of a country's economy, and it represents the total market value of all goods and services produced in a country during a given year.

Retail Sales:  The retail-sales report measures the total receipts of all retail stores in a given country.

Industrial Production:  This report shows the change in the production of factories, mines and utilities within a nation.

Consumer Price Index (CPI)  The CPI is a measure of the change in the prices of consumer goods across over 200 different categories.

Some of the other major indicators include the purchasing managers index (PMI), producer price index (PPI), durable goods report, employment cost index (ECI), and housing starts. And don't forget the many privately issued reports, the most famous of which is the Michigan Consumer Confidence Survey. All of these provide a valuable resource to traders, if used properly.

So, How Are These Used?
Since economic indicators gauge a country's economic state, changes in the conditions reported will therefore directly affect the price and volume of a country's currency. It is important to keep in mind, however, that the indicators discussed above are not the only things that affect a currency's price. There are third-party reports, technical factors, and many other things that also can drastically affect a currency's valuation. Here are a few useful tips that may help you when conducting fundamental analysis in the foreign exchange market:

Keep an economic calendar on hand that lists the indicators and when they are due to be released. Also, keep an eye on the future; often markets will move in anticipation of a certain indicator or report due to be released at a later time.

Be informed about the economic indicators that are capturing most of the market's attention at any given time. Such indicators are catalysts for the largest price and volume movements. For example, when the U.S. dollar is weak, inflation is often one of the most watched indicators.

Know the market expectations for the data, and then pay attention to whether or not the expectations are met. That is far more important than the data itself. Occasionally, there is a drastic difference between the expectations and actual results and, if there is, be aware of the possible justifications for this difference.

Don't react too quickly to the news. Oftentimes, numbers are released and then revised, and things can change quickly. Pay attention to these revisions, as they may be a useful tool for seeing the trends and reacting more accurately to future reports.

Conclusion
There are many economic indicators, and even more private reports that can be used to evaluate the fundamentals of forex. It's important to take the time to not only look at the numbers, but also understand what they mean and how they affect a nation's economy. When properly used, these indicators can be an invaluable resource for any currency trader.

Please note the above background information comes courtesy of Justin Kuepper at www.investorpedia.com

Now that you have some very good background on what fundamentals are…  From here on in you can throw it all out the window!  Here's why…

I would wager to say that 99% of forex traders have one simple goal in mind -  to take the money and run.   And…  Whether their goal is making 10 pips a trade or 100, they are still  just looking to exploit short term market patterns and movement.  So you see, since we have a relatively short exposure in the market, the big economic picture doesn't really need to concern us. 

Now I can hear some of you saying that what I am saying is bollocks so lets dig deeper.  Let me ask you this…  Why do you think it is so important to know what the market fundamentals are?  Well the answer I think most of you would say is that it helps tell you which way the major trend is going and you would be right but…  You can get the same information by looking to see what the daily, weekly and monthly charts are doing.  If they are climbing upwards, it is simply a reflection of the underlying fundamentals.  Besides, its a whole lot easier letting the charts tell you what the bias is versus having to spend hours and hours trying to decipher all the economic info. 

 Try and think of your charts as a "Readers Digest" version of the market fundamentals.

Besides wasting too much time thinking about how all the market fundamental bits and bobs fit together, it frees up my time to trade more clearly.  Let me explain… 

What I notice that happens quite often is that a trader will spent countless hours figuring out market movement and this creates a strong bias in their minds.  For example,  say their research says the US dollar is extremely weak and it is going to keep declining.  Well until the summer of 2008 I wouldn't have given your argument any challenge as the dollar kept dropping. 

Now here's where having a bias can get you financially decimated…  As long as you have this upwards bias in your mind, you will tend to keep only looking for buy opportunities and it will make you a lot of money until…  The market starts to sell off as it did in July and August of 2008.

You see, when a trader forms an opinion and it proves to be right, they have a very hard time knowing or admitting when their opinion has turned wrong.  When this happens they will keep trying to buy  even though the market is now going down.  Its like they have rose colored glassed on and don't see that things aren't as they appear. 

This happened during the stock market crash of 2000/2001 as they were so convinced the markets would go up forever that they failed to see the market collapsing around them. As a result they kept telling themselves the markets would bounce back and they kept buying as the market kept sinking lower and lower.   Anyway, you all know how that story ended.

Another reason you don't want to get locked into the big fundamental picture is because…   If you go back to a GBP/USD chart during the summer of 2008, you would see the charts were strongly up which meant the US dollar was super weak.  Now, flash forward and you will see this pair dropped from 2.0000 all the way down to its current valuation of 1.4390. 

Maybe fundamentally you could still come up with some good arguments why the Us dollar is destined to fall again like…  The Chinese wanting to replace the dollar as the world currency.  If that were to happen it wouldn't be good news for the greenback, but there are a lot of things that would happen to make this scenario play out.  With that in mind don't get caught in "what if" scenarios as they will only put a unrealistic bias in your head.

The bottom-line, is trade what you see, not what you want to see!

Back in the summer of 2008 I said the pound and euro were going into a downtrend and at that time know one else was saying that.  Was I a genius?  No, I simply looked at what the charts were telling me and wasn't caught up in what the fundamentals were saying.  In addition, I used a big rule of mine, which says…  "Never get married to your opinion".  This saved me from getting lost in what everyone else was saying at the time.

One last thing… You can get just as biased opinion from using technical tools, so make sure you are quick to realize when things have changed.

I hope this gives you some food for thought that can help you though these current tricky market conditions.

Until next week, peace and prosperity,

Jeff Wilde 

This issue sponsored by "The Black Dog System" - 74% winners for the past 6 months without any hype, fanfare or drama.  To read more click here…