Fundamental analysis is a study of the economy and is based on the assumption that the supply and demand for currencies is a result of economic processes that can be observed in practice and can be predicted. Fundamental analysis studies the relationship between the evolution of exchange rates and economic indicators, a relationship that it verifies and uses to make predictions.
For currencies, a fundamental trading strategy consists of strategic assessments in which a certain currency is traded based on virtually any criteria excluding the price action.
These criteria include the economic condition of the country that the currency represents, monetary policy, and other elements that are fundamental to economies.
The focus of fundamental analysis lies in the economic, social, and political forces that drive supply and demand. There is no single set of beliefs that guides fundamental analysis, yet most fundamental analysts look at various macroeconomic indicators, such as economic growth rates, interest rates, inflation, and unemployment. Several theories prevail as to how currencies should be valued.
Done alone, fundamental analysis can be stressful for traders who deal with commodities, currencies, and other margined products. The reason for this is that fundamental analysis often does not provide specific entry and exit points, and therefore it can be difficult for traders to control risk when using leverage techniques.
Currency prices are a reflection of the balance between supply and demand for currencies. Interest rates and the overall strength of the economy are the two primary factors that affect supply and demand. Economic indicators (for example, gross domestic product, foreign investment, and the trade balance) reflect the overall health of an economy. They are therefore responsible for the underlying changes in supply and demand for a particular currency. A tremendous amount of data relating to these indicators is released at regular intervals, and some of this data is significant. Data that is related to interest rates and international trade is analyzed closely.