Forex traders often turn to a variety of economic data to determine where a particular country’s economy and currency may be headed next. This data may include the following: Gross Domestic Product (GDP), imports, exports, employment, unemployment, growth, debt and many other factors. Collectively, these are often referred to as the fundamentals. Therefore, fundamental analysis refers to the analysis of any data, as well as the actual price patterns of the currency itself. The price patterns frequently impact the value of the currency on the forex market.
Supply and Demand
Like any other market, the value of currencies responds to changes in supply and demand. For example, the value of the Dollar (USD) will rise when the demand for this currency rises. The Dollar will drop in value when too many Dollars are available on the market, or the demand for the USD declines.
Forex Currency Pairs
The world’s currencies trade in pairs - one currency’s value either rises or drops in comparison to another. In fx trading, each currency has a three-letter abbreviation, and the trailing currency of any pair is considered the base currency. The price at any given time tells you how much of the base currency is needed to equal exactly one unit of the leading currency.
For example, when the EUR/USD pair is priced at 1.5000, this means that it takes 1.5 US Dollars to exchange for 1 Euro. If the Euro rises in value, then the EUR/USD price will also rise as more US Dollars are needed to buy each Euro. Likewise, if the Euro drops in value, then the price of the EUR/USD pair will also drop as fewer US Dollars are now required to equal each Euro.
The value of the leading Forex currency is not the only factor in determining the value of a particular currency pair. Any change in the value of the base currency obviously also affects this relationship. So, in the same example, if the US Dollar now rises in value, then the EUR/USD pair would drop as fewer Dollars are now needed to buy each Euro. If the US Dollar drops in value, then the EUR/USD price would rise, as more US Dollars are now required to equal each Euro.
Interest Rates
Another key factor that influences the value of a given currency is the constantly changing interest rate determined by the central bank of a particular country.
For example, if the Federal Reserve (Fed) in the United States lowers its interest rate, then the value of the US Dollar usually drops, causing the EUR/USD pair to rise. If the Fed raises interest rates, then the US Dollar will typically go up as well, causing the EUR/USD to drop.
Central banks are always caught in a delicate balancing act. If a country’s currency gets too strong, its exports become too expensive and other countries may look elsewhere.
Higher interest rates also tend to attract more foreign investments, which is why the currency of that country frequently goes up with the interest rates. Meanwhile, cheaper interest rates tend to stimulate lending inside the country and therefore economic growth.
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