Elements Of Fundamental Analysis – 1

Fundamental analysis is the process of analyzing the economic and socio-political news headlines released to the markets as part of the Economic Calendar, with the aim of trading currencies based on the prevailing market sentiment derived from the news that is released.  So we can refer to fundamental analysis as all the processes that you as a trader will undertake in order to trade the news.

Many traders would rather not talk about fundamental analysis. I have met many people who have dismissed fundamental analysis as an excessively risky way of trading forex, while some say things like “I only trade technically”. Either way, thinking this way is like trying to balance a chair on one leg – its incomplete. Traders who avoid fundamental trading are usually those who have heard of the bad experiences others have had trading the news. There are also others who have tried it with poor results and have consequently dismissed it as being too risky.

The truth is that most of the money made in the forex market is made by trading the news. The news is what moves the markets. A news release stamps a particular sentiment on a currency asset, and will determine whether people will buy or sell that currency. Hundreds of billions of dollars in global money exchanges hands on a single news event, and the net flow of trades will therefore determine the direction of the currency asset. At this time, no one is interested in if the currency has formed a double top or is forming an ascending triangle. Once the bias is in force, the currency will move along and all traders can do is to use technical hints to point out the best points of trade entry.

Trading the News: Key Issues In Fundamental Analysis

A single piece of news can dominate proceedings on a currency for months on end. A good example is the Eurozone sovereign debt crisis that has crashed the value of the Euro against the USD from 1.4938 in April 2011 to levels below 1.2600 as at August 2012. Considering that the EURUSD exchange rate had even fallen as low as 1.2041 during this period (a move of over 2,942 pips in 15 months) before its current rebound, there is no doubt that the news weighs heavily on currency sentiment.

Part of the reason why retail traders have so much unfounded fear of news trading is that they fail to understand the impact it can have on their account balance. A typical retail trader probably has a few hundred to a few thousand dollars in his account, and may trade a maximum of 1 Standard Lot per trade, with the potential to make $10 per pip. Institutional traders who take news trading much more seriously may trade up to 1,000 Standard lots per trade, with the capacity to make $10,000 per pip. If such traders cashed in on the bearish sentiment of the EURUSD that produced 2,942 pips in 15 months, that comes to $29.5 million on one single trade in 15 months. Can you imagine the effects such funds will have on the cash flow of an institutional trader? This is why institutional traders do not joke with news trading. They know its worth and invest insane amounts of money on the necessary infrastructure to help them pull off news trades successfully.

Trading the news is worth a shot once you decide it’s not dangerous but a more controlled way of trading and steadily increasing your capital.

Successful news trading will need the use of certain tools and methods. The model reproduced below is a simplification of the actual methods used by institutional traders. However, it will work for the retail trader if used seriously.

1) The trader must mimic the colocation structures put in place by institutional traders for fundamental analysis. Colocation simply means having your trading servers located in the exchange itself. This is predicated on data reception being quickest in servers located closer to the market action. For instance, if a trader intends to trade a US news release, he must have access to a server close to New York.

2) Following from (1) above, the trader must invest in virtual private servers for any expert advisors to be used, and must subscribe to ultra-low latency news feeds from organizations with news servers that are again close to the action. Institutional traders pay thousands of dollars for this service, and it gives them results. If you have to spend hundreds of dollars to gain thousands, then this is good business.

3) The trader must invest time in studying how different currency assets respond to news trades. This is also called Currency Correlation.  For instance, the way the EURUSD and USDJPY respond to the Non-Farm Payrolls numbers are different.  If a trader does not understand how a currency will behave in response to a particular news event, it is likely a trade can go wrong – really wrong fast!

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