As forex traders try to understand market movement and predict it reliably, they usually try to learn the underlying economic, political, and social factors that influence currency values. This approach to understanding the forex market is known as fundamental analysis. Though it’s not the only type of forex analysis that exists, it’s one of the most important. Unlike technical analysis, which deals with price patterns and market trends, fundamental analysis tries to discover the macroeconomic indicators and events that fuel price movements.
In this article, we will cover the components of forex fundamental analysis, the role of central banks, the impact of geopolitical events, and, at the end, compare fundamental and technical analysis. Whether you are just starting out in the trading world or are an experienced trader, understanding fundamental analysis is a key force in navigating the market efficiently. Read on to learn more.
Types of Forex Fundamental Analysis
In general, we can divide fundamental analysis into four types or perspectives: top-down analysis, bottom-up analysis, balancing trade and interest rates, and balancing supply and demand.
- Top-down analysis: In this approach, traders study macroeconomic factors and then with their way towards the details of how they affect the assets the traders want.
- Bottom-up analysis: In this approach, traders first analyze the instrument of the forex market that they want to use and work their way up to see how macroeconomic factors affect this instrument.
- Balance of trade and interest rates: This approach strives to understand the balance of trade agreements and exports and imports compared to interest rates, all of which affect currency value.
- Forces driving demand and supply: Understanding the supply and demand of an economy is a matter of both understanding trade surpluses and deficits, as well as employment rates and other economic indicators.
Key Components of Forex Fundamental Analysis
In fundamental analysis, traders have to evaluate economic trading indicators and forex economic calendars to understand what influences investor confidence and currency demand. Key components and economic indicators of forex fundamental analysis include:
Gross Domestic Product (GDP)
The Gross Domestic Product or GDP measures the total value of goods and services produced by the country. If a country’s GDP seems to be growing, it’s a sign of a robust economy, which subsequently leads to currency appreciation. An example of this is when the GDP of the U.S. grows faster than the GDP of the Eurozone. In this case, the U.S. dollar is strengthened against the euro. You can check the GDP of various countries here.
Inflation Rates
The inflation rate of a country influences the country’s currency value. Inflation rates are usually measured by what’s called the Consumer Price Index (CPI). Inflation rates directly affect purchasing power, making the currency less valuable (since it’s harder to purchase things in real life with it). Moderate inflation is normal for a currency, but high inflation is where traders should be cautious. In cases of high inflation, central banks can adjust interest rates to control inflation and impact currency strength.
Employment Data
The economic stability of a country is directly linked to the rate of employment in the country. In fundamental analysis, employment statistics such as unemployment rates give traders insight into the country’s economic health. High employment in a country means economic strength, which can boost the national currency.
Trade Balance
The trade balance of a country affects the currency demand. The trade balance is the difference between the exports and imports of a country. A trade surplus can boos a currency’s strength while a trade deficit can weaken it. An important note to make here is that sometimes these indicators aren’t as clean-cut as explained on paper. For example, the U.S. has had a large trade deficit for years, and yet the dollar has gone on strong alongside it. This is because of other factors, such as the U.S. dollar being used as a global reserve currency and other geopolitical factors. Keep this example in mind as an indicator that fundamental analysis needs a deep understanding of economic theory alongside following forex signals.
Central Banks: Popular Sources for Forex Fundamental Analysis
It’s important to remember that currencies are paired with central banks that directly influence them. The monetary policies of a central bank can directly influence the strength of a currency. There are various mechanisms through which a central bank can influence currency value and, in turn, influence forex markets. Here are a few of the most important roles of central banks in the forex market:
Interest Rate Decisions
Central banks decide on the interest rate of a currency. Their decision are usually in the pursuit of stabilizing the economy and controlling inflation. When a currency’s interest rate increases, it signals better returns on investments denominated in that currency, which leads to foreign capital strengthening that currency. On the other hand, lower interest rates lead to currency depreciation.
Quantitative Easing (QE)
Quantitative Easing, or QE, is the act of central banks purchasing government securities to inject liquidity into the economy. This act simultaneously stimulates economic growth while depreciating currency value because of the increased money supply.
Forward Guidance
The forward guidance of central banks signals their intentions for future monetary policies. These signals are important for traders since they help them anticipate policy changes that can affect currency value and act accordingly.
Market Expectations
It’s important to also understand that it’s not just what the central bank does that affects the forex market, but also what the market expects the central bank to do that also affects the market. In other words, the forex market reacts to not just policy changes by the central bank, but also the expectation of a policy change. If traders anticipate a rate hike, the currency may strengthen in advance of the actual decision.
How to Use Forex Fundamental Analysis in Geopolitical Events
Geopolitical events affect currency movements and can cause significant volatility. The influence that geopolitical events have on the forex market is due to how they influence the confidence of investors in economic stability. Traders have to be aware of global events and follow them closely since these events can potentially lead to currency fluctuations:
Elections and Political Stability
The political stability of a country affects investor confidence, which in turn affects currency value. Political instability can range from political disputes between governing forces in a country to an unexpected election outcome.
Trade Agreements and Disputes
Trade agreements between countries can boost the exports of a country, which strengthens its currency. On the other hand, a trade dispute or tariff can hinder economic performance, devaluing a currency.
Conflicts and Wars
Needless to say, a conflict or war in a region leads to risk aversion among investors who usually seek safe-haven currencies such as the U.S. dollar, Swiss franc, or Japanese yen, which increases their value.
Natural Disasters and Pandemics
Pandemics and natural disasters can disrupt economic activity in a country, affecting the currency strength. They can also lead to worldwide volatility in the forex market, such as the COVID-19 pandemic.
Fundamental Analysis vs Technical Analysis in Forex: Which is Better?
Fundamental analysis and technical analysis each have their benefits and give different insights into the forex market. Technical analysis focuses on price movements and patterns, while fundamental analysis provides insights into the underlying economic factors affecting currencies.
Fundamental Analysis for Market Direction
It’s best to use fundamental analysis when we are trying to assess market direction and determine long-term economic trajectories. For example, economic indicators that suggest a strong U.S. dollar will slowly take effect throughout a long-term trend. Though specific events can cause high volatility in the short term, most fundamental analysis deals with long-term thinking.
Technical Analysis for Entry and Exit Points
On the other hand, technical analysis can help traders understand the here and now of the forex market by analyzing charts and trends. The optimal use of technical analysis is to determine the best entry and exit points of the market, which can be quite useful even when a trader has understood the broader context of the forex market using fundamental analysis.
Fundamental analysis gives you the why behind market moves—but turning that knowledge into daily consistency? That’s where the 5-3-1 Rule in Forex comes into play.
Combining Fundamental and Technical Analyses
Combining both types of analyses in the forex market leads to more informed risk management. With fundamental analysis, traders can anticipate market shifts, whereas by using technical analysis, they can determine the exact stop-loss levels they need. It’s important to consider the myriad of factors involved in the forex market by using all types of analysis and leveraging the strengths of each one.
What is the Best Fundamental Analysis in Forex?
In forex fundamental analysis, it’s important for traders to understand the economic forces driving currency values and make forex market predictions. To become an excellent trader, traders have to use key indicators, central bank policies, and geopolitical events to understand the market realities. Though a macroeconomic perspective on the forex market won’t guarantee success, it will certainly help traders make informed decisions that they can then execute precisely using technical analysis.
Open an account with us at STPTrading to put your fundamental and technical analyses to use. As one of the best forex brokers of 2025, we offer flexibility because of our various types of trading accounts at STPTrading. We also offer free forex signals that traders can use alongside their own analyses to make informed decisions using trading indicators.
While this guide focuses on fundamentals, don’t overlook the technical and sentiment components. Explore the full scope of the 3 types of analysis in Forex to enhance your decision-making.
