The Fed’s future path still seems more bullish than the European Central Bank. If so, the yiel...
Beginners Guide to Finding Great Forex Trades (Part 5)
08/14/2009 12:01 am EST
We have found that forex traders tend to focus on either fundamental or technical analysis in their trading and will often completely dismiss the other style. We encourage traders to spend the time it takes to understand the underlying forces moving the market (fundamentals), as well as what is happening in price, volume, and volatility (technicals).
To that end, let’s define fundamental analysis. We separate fundamental forces into two categories: economic fundamentals and intermarket fundamentals.
Economic fundamentals are those that reflect growth, trade, and production within various economies. These include most of the news in forex (we will talk about news analysis in greater detail later). Although fundamentals like gross domestic product (GDP) or trade data can be helpful, it is always difficult to find a common denominator when comparing these fundamentals across borders. Therefore, we tend to work mostly with those fundamentals that fall into intermarket fundamentals.
Intermarket fundamentals include interest rates, equity yields, relative strength, commodity prices, and sentiment information—like institutional commitment of traders and volatility. These may not sound like traditional fundamental factors, but we believe they are far more useful and predictive than the official and lagging news releases of economic reports.
The advantage of intermarket fundamentals is that they are exchange traded. For example, investors’ predictions regarding where interest rates are going is not being fed to you through a single, official source that will lag the real market. It is coming through the live market. Market-traded information is usually real-time and pulls from distributed sources, which enables it to reflect consensus information much more effectively than a survey ever could. Most technical analysts will argue that all the news is wrapped up in prices anyway, so getting to the exchange-traded information is much more efficient.
There are two things you need to know about intermarket fundamentals:
1) Higher yields available in one economy should increase demand for that currency, which will fundamentally strengthen that currency.
2) Investors calculate yields based on various investments, including bonds, equities, deposits, and more.
Of course, since forex pairs move relative to each other, these fundamentals only have value when compared to the same measures across currency borders.
Imagine, for example, that yields in Australia are much higher than those available in the United States and have been trending higher for a few years. This difference in yields creates a yield differential that, fundamentally, should push the Australian dollar (AUD) up against the US dollar (USD).
Another way to look at this is as a seesaw. If the AUD is on the left side of the seesaw and the USD is on the right side, and the AUD is outweighing the USD from a fundamental perspective, then the AUD/USD seesaw will be pointing up and to the right. By no coincidence, so will the AUD/USD currency pair.
Where to Find Fundamental Information and Data
On the LearningMarkets.com Web site, we do all the hard work of tracking down and sifting through the important fundamental data and news. We track the most important fundamentals on each currency pair and put all of the information into one place—the fundamental seesaw.
The fundamental seesaw for each currency pair may be equally balanced or clearly weighted in favor of one currency over another. When that difference is dramatic, you can use that information to help set your bias of being either bullish or bearish toward the currency pair. The score at the bottom of each fundamental seesaw helps you determine whether you are looking for long trades (if the base currency is favored) or short trades (if the quote currency is favored.)
Some Fundamental Seesaw Components
We look at several components to create the fundamental seesaw score. We derive some of these from intermarket information that it is updated in a more timely manner, and we derive the others from economic announcement measures, like GDP or inflation. Here are a few of the components we look at when creating the fundamental seesaw for each currency pair:
Commitment of Traders (COT) Chart: While the COT chart does not measure a yield that is traded on an exchange, the COT chart does represent the positions of institutional traders. It shows whether they are net long or net short a particular currency pair.
Equity Market Comparison Chart: Equities cover such a broad spectrum of economic sectors that we take two different measures of this important market. The equity comparison chart looks at the relative price performance of stocks during the past week from the economies represented by the two currencies in the currency pair. The trend of this yield is very sensitive and can be a great alert for coming changes.
Interest Rate Spread: The interest rate spread displays the differential between the target rates, or primary interest rates, set by the central banks of the two economies represented by the currencies in the currency pair.
Ten-Year Yield Spread: The ten-year spread measures the difference between the yields available on the ten-year government bonds in the economies represented by the currencies in the currency pair. This is useful measure of investment risk in each of the economies. When risk levels increase, yields on government bonds typically decrease. Conversely, when risk levels decrease, yields on government bonds typically increase.
Equity Yield Spread: Equity yield spreads measure the difference in indexed stock returns between the stock markets in the economies represented by the currencies in the currency pair. The yields measured here show the difference in performance between the two markets during the past 12 months.
Technical Analysis: While technical analysis is not part of the fundamental score, each currency pair has a link to the pair’s technical analysis video on LearningMarkets.com. In the video, we look at the support and resistance levels we are tracking as well as other technical indicators.
Now watch the video below for more:
|Read Part 1 | Read Part 2 | Read Part 3 | Read Part 4|
By John Jagerson of LearningMarkets.com.
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