We begin in this chapter with an exploration of the forces that move the prices:
the fundamentals. The
reader will learn why fundamentals are important to foreign
exchange (forex) traders
as well as what kind of economic activity are
most important in
affecting price movements. These include interest rates, interest rate
differentials, economic
growth, and sentiment regarding the U.S. dollar.
WHY FUNDAMENTALS ARE
IMPORTANT
In many ways, forex trading is similar to playing a game. You have
an opponent (the market). In game of chance the key feature is that everyone
faces the same odds and therefore the same level of information. In these
games, no player can change the odds.
Playing forex, however, is not a game of odds. Participants in
forex trading do not
share the same amount of
information. In forex, this asymmetry of information results in advantages and
disadvantages to trades. Some players have more information than the others. In
forex, information about fundamental aspects of economies does not arrive simultaneously
to all participants. The real important question is what kind of knowledge and
information can improve trading performance. The search for an edge starts with
a fundamental understanding of the nature of the forex market. Having a
foundation of knowledge in fundamentals is a first step in evolving into a
winning trader.
In getting acquainted with the forex market, most people start by
looking only at price charts and price patterns. This is called technical
analysis. But the study of what moves those charts is called fundamental
analysis. The goal of Part I is to identify the components of fundamental
analysis in regard to forex and then provide a recipe for developing your own
fundamental analysis of a currency pair.
Why take time to look at forex fundamentals? Why should
fundamentals matter if a
trade is done off a
short-term time interval such as the 5-minute chart? The short answer is that
one cannot separate the fundamentals from the technical analysis without
exposing oneself to great distortions in understanding the forex market.
Foreign exchange isby its nature both fundamental and technical and reflect the
increased globalization of the world economy.
It is worthwhile to note the comments of the late, great Milton
Friedman in a 2005 conversation with Dallas Fed president Richard Fisher:
The really remarkable
thing about the world is how people cooperate together.
How somebody in China
makes a little bit of your television set. Or somebody
in Malaysia produces
some rubber. And that rubber is used by somebody in the
United States to put on
the tip of a pencil, or in some other way. What has happened has been an
enormous expansion in the opportunities for cooperation.
Consider the following: every transaction in the world settles in
a currency. Whether it is a consumer purchase, an imported or exported item, an
investment in an equity, or even cash under the mattress, the world’s economic
activity is essentially a
flow of money. What
makes forex fascinating as a market and as a trading vehicle is
the fact that currencies
provide an intimate linkage to the world economy. The currency trader by
putting on a currency trade becomes a participant the world economy.
The trader is participating as a speculator looking for a very
short-term profit. The forex trader is riding on a global wave. Some will surf
the waves, jumping on and off; others will stay in much longer and face the
volatility. Forex trading becomes possible because the world is constantly
assessing and reassessing the value of one currency against another. The forex
currency trader is looking to tap into this stream of changing values.
The challenge is to find the right combination of tools that can
assist the trader infinding high-probability profitable trades. In meeting this
challenge, the first step is understanding what moves currencies over time. In
putting together a recipe for successful forex trading, knowing the fundamental
chemistry of forex is highly recommended. Anyone who doubts this should simply
look at daily headlines that evoke names and places that are part of the daily
consciousness of a trader. These names should be familiar to all traders:
Bernanke, Fukui, Trichet, Xiaochuan. The words and decisions of these central bankers
of the United States, the Bank of Japan, the European Central Bank, and the
Bank of China alert the trader to interest rate policy and news that affect
sentiment about the direction of the dollar. Mention the capitals Pyongdong,
Baghdad, Tehran, and they evoke emotions of fear and crises. Detect news about
retail giant Wal-Mart’s sales, and one starts anticipating a potential reaction
in the currency markets. These and other factors mix together and form the
chemistry of forex, which results in shifts of sentiment regarding the U.S.
dollar. These shifts in sentiment cause price reactions and shift the balance
between buyers and sellers. Let’s look in more detail at these fundamental factors.
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