Lesson 12 – Application of Fundamental Analysis

Fundamental analysis is the comprehensive analysis of factors, such as the economic outlook, political situations and policies of central banks, which can cause fluctuations in the exchange rates of the different countries so as to determine the general trends of the market in the foreseeable future. Of the many factors, economic situation is the most important one that frequently creates fluctuations in exchange rates. Factors such as economic growth, international balance of payments and interest rate adjustments are some of the useful indicators you can look out for.

Political and central bank’s interventions do not occur frequently, but when they do, they often have a catastrophic impact on the market. You must be able to react quickly and seize these great investment opportunities. However, many investors, especially beginners to forex trading, may be confused and overwhelmed by the myriad of factors and economic indicators. They find that everything seems very complex and have difficulty understanding the underlying rules of exchange rate movements.

Actually, once you have understood the general principles, you just have to keep in mind one important fact: the factors mentioned above rarely occur at the same time. At any point in history, there will be different events and factors. Even if these events and factors happened at the same time, there will always be one or two dominant ones that dictate the market. As an investor, you must know the factors you should use for analysis and not be baffled by the sheer amount of information.

For example, during the US presidential election in November 2000, apart from the US economy, the critical factor that will affect the forex market was the result of the election. This was the key factor during that time. Why? The presidential candidate George W Bush advocated that the US should not interfere with the European economies excessively,

including the forex market. During that time, the Euro was extremely weak; several European economists and financial experts proclaimed their support for the Euro and even warn investors against dumping the currency, but to no avail. The market felt that without the support from the US, the Euro is doomed. Under such a situation, George W Bush’s statement undoubtedly dealt a crushing blow to the Euro. It will be bad news for the Euro if he was to be elected as the president. From this analysis, it is important for investors to pay close attention to the result of the US presidential election.

During the vote count, the exchange rate for EUR/USD plunged when Bush was in the pole position and rebounded when Al Gore regained the lead.

After the media announced that Bush has won the election, the Euro sank by nearly 100 pips. Due to a series of vote counting disputes in Florida, the Florida High Court ruled on 8 December to allow manual recounts in some counties. This put Al Gore in a good position to overturn the result. At first, the exchange rate for EUR/USD declined from 0.89 to about 0.88 as more people bought the US Dollar after the release of the Non-Farm Payroll figure of 94,000 people which reflected its growing economy. However, following the Florida High Court’s decision, the Euro rebounded quickly from about 0.88 to about 0.89. This is a classic example of how a single dominant factor, the Presidential Election in this case, can affect the exchange rates. If you cannot grasp these key factors, it will be very difficult to forecast market trend and profit from it.