Forex Fundamentals -How to Master them?

Learning forex fundamentals boil down to one single law - law of supply and demand.

Economists use capital flows and trade flows to measure supply and demand forces.

In this section we will dissect how capital flows, trade flows, and various theories that relate to supply and demand for a specific currency.

If demand exceeds supply then price goes up and if supply exceeds demand price goes down.

By understanding supply and demand factors traders can make mid-term to future valuation of a currency.

In order to better understand forex fundamentals, we focus our attention to various macroeconomic indicator such as growth rates, interest rates, inflation and unemployment.

These macroeconomic indicators indicate potential changes to the social, economical and political environment of a specific country.

Any positive shift in these macroeconomic indicator of a country will be accompanied by demand for its currency.

Any negative shift in these macroeconomic indicator will be accompanied by supply for its currency causing it to depreciate.

No matter, whether the demand is for conversion purpose, hedging or speculative purpose actual movement in forex market would not occur without demand or supply forces.

Mastering these fundamental analysis enable traders to determine a currency's proper valuation on a medium-term basis, as well as its probable future valuation.

For example, we experienced strong U.S. dollar during the U.S. internet boom from 1999 to the end of 2001. During this period, investment capital flocked to the booming U.S. economy from all over the globe in order to harvest better yields.

Foreign investors, who sold their local currencies and purchased the U.S. dollars in order to participate in the U.S. equity and bond market literally drove demand for the U.S. dollars.

As a result U.S. dollar appreciated against all other major currencies.

However, the tech bubble burst at the end of 2001 lead foreign investors as well as domestic investors to sell the U.S. dollars due to uncertainty in the U.S. economy. This caused excess U.S. dollar supply in the financial market resulting in its depreciation.

So supply and demand cause price gyration.

If you plan to invest your time and energy in studying forex market you will be wise to master these forex fundamental theories.

  1. The Balance of Payments (BOP) Theory

  2. Purchasing Power Parity (PPP) Theory

  3. Interest Rate Parity (IRP) Theory

  4. Monetary Model Theory

  5. Interest Rate Differential Model Theory

  6. Asset Market Model Theory

  7. Currency Substitution Model Theory

So what forex fundamental analysis tools do you employ in your trading?

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