Fundamentals and Technical Analysis. 

Fundamentals

There are several fundamental factors which influence a country's currency.  These include interest rates, the economy (GDP, employment), budget (surplus or deficit), trade balance (surplus or deficit) and political stability. 

In the case of interest rates, as a country increases interest rates, investors tend to seek fixed income investments in that country to profit from these higher rates.  For example, if the Japanese interest rates are 1% and the U.S. interest rates are 4.25%, Japanese investors could be expected to sell yen denominated investments in order to fund the purchase of U.S. dollar denominated investments.  This in turn would have the effect of increasing the USD/JPY trading value (that is, the U.S. dollar would go up in value relative to the Japanese yen).

In the case of a country's budget and trade balance, deficits tend to be a negative factor for a country's currency and a surplus tends to be a positive factor for a country's currency. 

A country's economy also tends to be a factor in determining a currency's value.  A strong and growing economy measured in terms of GDP growth and employment tends to attract currency inflows (to facilitate investment) and hence promotes a strong currency. 

In monitoring these items, there are a plethora of data sources which traders look at.  Some of the leading ones are the following:

  1. Non-Farm Payroll Employment.  (released monthly -- see schedule)
  2. Federal Open Market Committee (FOMC) pronouncements (i.e., interest rate decisions, minutes, press releases, transcripts, Beige Book)
  3. Trade Balance (current account surplus or deficit)
  4. Consumer Price Index (inflation or deflation)
  5. Retail Sales (A monthly measurement of all goods sold by retailers based on a sampling of retail stores of different types and sizes.)
  6. GDP (the output of goods and services produced by labor and property located in the United States)
  7. Durable Goods
  8. Treasury International Capital (TIC) System data (showing investments flowing into and out of the U.S.).

Each of these items listed tend to be closely followed by traders and can move the market and/or start or reverse a trend.  You may want to either bookmark this page or bookmark each of the web pages listed above.  To the extent possible, you can sign up to receive monthly or periodic releases via email as well. 

  

Technical Analysis

There are endless technical indicators that Forex traders use to signal trades.  In fact, entire books have been devoted to the topic.  Here, we are going to discuss four (4) of the most popular technical indicators that Forex traders use.  These are the (a) Moving Average Convergence/Divergence ("MACD"), (b) the stochastic oscillator, (c) the relative strength index or RSI and (d) Bollinger bands.  Even if you trade based on the fundamentals, an understanding of technical analysis is useful since it gives you a basis to understand what drives the trading of the majority of Forex traders. 

1.  MACD.  The MACD is one of the simplest and most reliable indicators available. The MACD was invented in 1979 by Gerald Appel.   MACD uses moving averages (which are lagging indicators formed by computing the average price of a currency over a specified number of periods) to create a momentum oscillator.   This is accomplished by subtracting a longer moving average from a shorter moving average.  The two that are typically used are the 26-day and 12-day moving averages. The resulting plot forms a line that oscillates above and below zero, without any upper or lower limits. 

A bullish crossover occurs when MACD moves above zero and a bearish crossover occurs when MACD moves below zero

The MACD can also be used as an overbought or oversold indicator. For example, if the price makes a new high or a new low but the MACD does not, this indicates a divergence between price and momentum. In the case of a new low for the MACD while the currency pair does not also make a new low, this is a bearish divergence, indicating a possible oversold condition. Alternatively, if the MACD is making new highs while the currency pair fails to attain new highs, this is a bullish divergence, indicating a possible overbought condition. An MACD chart for the EUR/USD pair is shown below. 

Fundamental and Technical Forex Analysis

2.  Stochastic Oscillator

The Stochastic Oscillator  is used to indicate overbought and oversold conditions on a scale of 0-100%.  Readings above 80 indicate overbought conditions (and is a sell signal) and readings below 20 indicate oversold conditions (and is a buy signal).  In addition, divergence between the stochastic lines and the price action of the underlying instrument can also produce a trading signal.

Fundamental and Technical Forex Analysis

3.  RSI

The RSI is plotted on a vertical scale from 0 to 100.  A level of 70 suggests the market may have peaked (and the market is overbought), and a level under 30 implies selling may be losing momentum (and the market is oversold). Unfortunately, trending markets tend to show a high or low level for an extended period of time.  However, if a long term uptrend is in place and a level of 30 or lower is attained, this may represent a good entry point.  By contrast, if a long term downtrend is in place and a level of 70 or higher is attained, this may be a good exit point. 

Even if the market is not trending and is in a trading range, this indicator can also be very useful since a reading of 30 or below would indicate a lower end of the range (and would be a buy signal) and a reading of 70 or higher would indicate a higher end of the range (and would be a sell signal). 

The standard time frame for the RSI indicator is 14 periods, although 9 and 25 periods are also commonly used.

Fundamental and Technical Forex Analysis

4.  Bollinger Bands

Many Forex traders use Bollinger Bands primarily to determine overbought and oversold level.  When the trading price touches the upper Bollinger Band, the currency pair is sold and when the trading price touches the lower Bollinger Band, the currency pair is purchased.  In range-bound markets this technique works well. 

Other Forex traders use Bollinger Bands to signal a price breakout.  When prices break above or below the upper or lower Bollinger Band, these traders will then take a position in the direction of the breakout.  

 

Below, you will see the upper and lower bands (for the EUR/USD pair) and how the pair has generally traded within them.

 

Fundamental and Technical Forex Analysis
 

None of these indicators can be used by themselves in isolation to achieve good trading results.  If used together and coupled with appropriate stops and good money management skills, they can provide a solid foundation for traders. 

  

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