What Affects Currency Values?
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
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.
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:
- Gross Domestic Product (GDP)
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. Since the GDP figure itself is often
considered a lagging indicator, most traders focus on the two reports
that are issued in the months before the final GDP figures: the advance
report and the preliminary report. Significant revisions between these
reports can cause considerable volatility. The GDP is somewhat analogous
to the gross profit margin of a publicly traded company in that they
are both measures of internal growth.
- Retail Sales
The
retail-sales report measures the total receipts of all retail stores in
a given country. This measurement is derived from a diverse sample of
retail stores throughout a nation. The report is particularly useful
because it is a timely indicator of broad consumer spending patterns
that is adjusted for seasonal variables. It can be used to predict the
performance of more important lagging indicators, and to assess the
immediate direction of an economy. Revisions to advanced reports of
retail sales can cause significant volatility. The retail sales report
can be compared to the sales activity of a publicly traded company.
- Industrial Production
This
report shows the change in the production of factories, mines and
utilities within a nation. It also reports their 'capacity
utilizations', the degree to which the capacity of each of these
factories is being used. It is ideal for a nation to see an increase of
production while being at its maximum or near maximum capacity
utilization.
Traders
using this indicator are usually concerned with utility production,
which can be extremely volatile since the utilities industry, and in
turn the trading of and demand for energy, is heavily affected by
changes in weather. Significant revisions between reports can be caused
by weather changes, which in turn, can cause volatility in the nation's
currency.
- Consumer Price Index (CPI)
The
CPI is a measure of the change in the prices of consumer goods across
over 200 different categories. This report, when compared to a nation's
exports, can be used to see if a country is making or losing money on
its products and services. Be careful, however, to monitor the exports -
it is a focus that is popular with many traders because the prices of
exports often change relative to a currency's strength or weakness.
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.
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.
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.
