Kathleen Brooks on Forex. Kathleen Brooks
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Hence I would write long treatises about how oversold the dollar was, but I could never make a winning trade. I grasped economics and the markets fairly quickly, but something wasn’t right. The dollar continued to go against me and I wanted to know why. That was when I learned a bit more theory about the importance of central banks, relative interest rate strategies, changing global growth dynamics and the concept of the safe haven.
As intelligent as I thought all of this new knowledge made me sound, I quickly realised that every time I thought the signals pointed to a stronger dollar, it weakened, and vice versa. Was this market nuts, or should I just give up the challenge of trying to teach myself something I knew nothing about and go and work in something more suited to my academic background?
Luckily I stuck with it and after some time I started to grasp that although you could be fundamentally right, you could be technically wrong. That was when it clicked; you need to use technical analysis too.
Back to my desk at BP, the guy I sat next to was always trying to show off his technical analysis skills and used fancy words that he knew would confuse me. I kept looking over his shoulder and eventually picked up a few terms the technicians like to throw about: support, resistance, MACD (and no, it’s not a burger), RSI and Fibonacci. This last point solidified my affection for the FX market. Fibonacci numbers may have been discovered by man but they are derived from nature and this resonated with me. There is a magical, almost mystical, side to how financial markets move, hence price movements tend to follow patterns in nature, and that was a major comfort to me.
Try as I might though, I could only get interested in a few of the elements of technical analysis. Too many lines on the chart, with bull and bear flags popping up every few minutes, left me blurry eyed. While I started to appreciate the benefits of technical analysis I needed something more. That was when it came to me – you can’t trade just on the fundamentals or the technicals, you need to fuse them. It seemed to me that the medium-term direction of a cross was down to the fundamentals but the day-to-day price moves, or intra-daily price moves, were all down to technicals.
I decided to stop trying to do what I thought I should do and start doing what I enjoy. I decided to concentrate on the fundamentals and combine them with my favourite technical indicators. That was a match made in heaven for me. That’s not to say that I became the most profitable trader in the world, but instead I started to enjoy what I was doing and felt more in control. Hence the birth of my forex philosophy.
After a spell away from foreign exchange and back at graduate school (still not economics, instead journalism) I re-entered the retail FX market a few years back. This has given me the chance to further refine my forex trading approach, which is what I will share with you.
Thank you for reading.
Kathleen Brooks, London, 2013
Introduction
The term fundamental analysis is very widely used, but what does it actually mean? The definition of fundamental includes:
The foundation or base, forming an essential component of a system and something of great importance.
There are also musical, religious and scientific definitions of fundamental but its definition in relation to the FX market is quite specific – it is the study of the underlying factors that drive a currency’s price. In the FX market these underlying factors include the economy, central banks and politics.
We use fundamental analysis in the forex market to help us answer a few basic questions related to these factors, for example:
1 Which economies in the world are growing?
2 Is the growth healthy and sustainable?
3 What are governments and central banks doing to manage their economies?
4 What is the political situation?
The forex trader making use of fundamental analysis takes the answers to these questions and applies them to the decisions they make when placing a trade in the forex market. To explain how this is done I will work through some real-life examples of how to trade using fundamental analysis later in the book.
Trading using economic data
The way to get the information needed for fundamental analysis is to look at the official economic data releases. For most of the world’s major economies, economic data is released regularly and it gives a glimpse of the overall economy and how fast it is growing. The key thing for me is that economic growth means future prosperity, which should then equate to a strengthening currency. Traders seek out growth because that is usually where the best opportunities lie to jump on an uptrend. Alternatively, economic data showing weakness in a country’s economy has the effect of weakening the currency.
The markets have a tendency to price in future growth and prosperity. The forex market, like the stock market, is thought to price in future growth expectations up to six months in advance. Hence markets don’t wait for the GDP release that comes out every three months before deciding on the direction of a currency; they react to the incremental flow of data from economic indicators throughout the month in anticipation of what that means for GDP and the overall health of the economy.
In addition to GDP the other indicators include inflation data, retail sales, industrial and manufacturing data, and data on consumer confidence. These are a timely update on the state of the economy and the occasions of their release can be major market-moving events.
In fact, there are thousands of economic indicators and it could make you dizzy if you tried to analyse them all and determine what they mean for growth. As an example of some of the kookier ways of measuring economic growth, some people may look at the hog market to try and detect Chinese consumption of pork and use that to deduce the strength of the Chinese economy. Others have been known to search out demand for a certain chemical found in paint and then try to apply that to demand for housing in the US.
Thankfully there are more accessible ways to understand what is going on from an economic perspective and for some people it is most effective to narrow the list down to a few key indicators. It is also possible to prioritise the indicators so that you can organise your analysis and know which to pay most attention to. I will now move on to introduce the economic indicators that I have found to be of most use in my own fundamental analysis. Before I do, a couple of words on finding economic data.
Use of an economic calendar
It is important to know when economic data is released and the easiest way to get this information is by using a calendar. You can get reliable up-to-date calendars on economic news websites like Bloomberg (www.bloomberg.com/markets/economic-calendar), some blogs have them – like Forex Factory (www.forexfactory.com), and the financial press often prints economic calendars at the start of each week. Also, ask your FX broker as they may provide you with a free calendar. Some even contain widgets that let you place orders or trade directly from the calendar.
Consensus
The key thing for traders to remember is that the actual data that comes out is only relevant based on whether it hits, misses or exceeds consensus. Consensus is an important word for the markets. Usually economic data calendars include the market’s expectation of the data release. The expected number is the mean of estimates from a number of economists who have been polled prior to the event and asked to give their views on what the number will be. Reuters and Bloomberg are some of the most popular data providers that measure the street’s expectations prior to major data releases.
As a general rule, a data miss (the figures released are worse than the forecasts) can be currency negative, a number around expectations usually has a negligible effect, and if the reading exceeds expectations this tends to be currency positive.