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Oh, Fundamentals are fundamentals

And technicals are technicals

And never the twain shall meet

… apologies to Kipling, and those who don’t know we’re kidding.

We have found that traders tend to focus on one type of analysis or the other in their trading and will often completely dismiss other types. We encourage traders to spend the time it takes to understand the underlying forces moving the market (fundamentals) as well as what is happening in price, volume and volatility (technicals.)

To that end, let’s define Fundamental Analysis. We separate fundamental forces into two categories:

Economic Fundamentals

Economic Fundamentals are those that reflect growth, trade and production. These include most of the news in the forex (we will talk about news analysis in greater detail later). Although fundamentals like GDP or trade data can be helpful, it is always difficult to find the common denominator when comparing these fundamentals across borders. Therefore we tend to work mostly with those fundamentals that fall into another category

Market Traded or Intermarket Fundamentals.  

Intermarket fundamentals include interest rates, equity yields, relative strength, commodity prices and sentiment information; like institutional commitment and volatility. These may not sound like traditional fundamental factors but we believe they are far more useful and predictive than the official and lagging news releases of economic reports.

What you will learn:

- Fundamentals are not just news announcements

- Fundamental analysis can help define the trend

- Fundamental analysis can be used to identify entries and exits

- Exchange traded fundamentals reflect a broader spectrum of opinions and consensus

The advantage of looking at fundamentals this way is that they are exchange traded. For example, interest rate information is not being fed to you through a single official source that will lag the real market. Market traded information pulls from very distributed sources to reflect consensus information much more effectively than a survey ever could. Most technical analysts will argue that all the news is wrapped up in prices anyway so getting to the exchange traded information is much more efficient.

There are two things you need to know about this kind of analysis.

1. Higher yields available in one economy should fundamentally strengthen its currency.

2. Yields are available returns from bonds, equities, deposits and other investments

Of course, since forex pairs move relative to each other, these fundamentals or yields only have value when compared to the same measures across currency borders.

Imagine, for example that yields in Australia (AUD) are much higher and have been trending higher than those available in the United States (USD) for a few years. That creates a yield, or fundamental differential, that should push the AUD up against the USD.

Another way to look at this is as a see-saw. If the AUD is outweighing the USD from a fundamental perspective, then the AUD/USD see-saw will be pointing up and to the right. By no coincidence – so will the AUD/USD currency pair.

On the PFX website we track the most important yield and sentiment fundamentals in each the pair’s dashboard pages. You can find these for each of the majors and a few crosses on the pair’s link from the main menu.

For each measure, we insert a positive or negative score for each currency in the pair. They may be very equally balanced or clearly weighted in favor of one currency over the other. When that difference is very dramatic you can use that information to help set your bias towards the currency pair. The score helps you determine whether you are looking for long trades (if the base currency is favored) or short trades (if the quote currency is favored.) 

Pairs components

There are several measures that we look at to create this fundamental score. Each of these are derived from market information so it is much more relevant and timely than a more difficult to compare economic announcement measure like GDP or inflation.

Interest rate spread: This displays the differential between the target rates or primary interest rates set by the central banks of the two currencies.

10-Year Yield Spread: This measures the difference between the yields available on the 10-year government bonds between the two currencies. This is useful information as a measure of risk and in some cases other yields like mortgage debt in the US .

Equity Yield Spread: This measures the difference in indexed stock returns between the two currencies. The yields measured here is the difference between performance of the two markets over the trailing 12 months,

Commitment of Traders (COT) Chart: While the COT chart does not measure a yield that is traded on an exchange the COT chart does represent the positions of institutional traders. It shows whether they are net long or short on a particular pair and the orange line, which is what is scored, measures the rate of change of their commitment to or from those positions.

Equity Market Comparison Chart: Equities cover such a broad spectrum of economic sectors we take two different measures of this important market. The equity comparison chart looks at the relative price performance of stocks from the two currencies. It shows relative performance over the last 7 days. The trend of this yield is very sensitive and can be a great alert for coming changes.

Technical Analysis: While this is not part of the fundamental score, each pair has a link to the pair’s video on the PFX site. In the video, we look at currency support and resistance levels we are tracking as well as other intermarket issues at play.  

Video Archives

For a larger version of the video, right click and select the full screen option.