What is Forex fundamental analysis?

The forex fundamental analyst identifies and measures factors that determine the intrinsic value of a financial instrument, such as the general economic and political environment, and including any that affect supply and demand for the underlying product or service. If there is a decrease in supply but the level of demand remains the same, then there will be an increase in market prices. An increase in supply produces the opposite effect.

For example, an analyst for a given currency studies the supply and demand for the country's currency, products or services (Merchandise Trade); its management quality and government policies; its historic and forecasted performance; its future plans and the most important for the shorter term, all the economic indicators.

From this data, the analyst constructs a model to determine the current and forecasted value of a currency against an other. The basic idea is that unmatched increases in supply tend to depress the currency value, while unmatched increases in demand tend to increase the currency value. Once the analyst estimates intrinsic value, he compares it to the current exchange rate and decides whether the currency ought to rise or fall.

One difficulty with fundamental analysis is accurately measuring the relationships among the variables. Necessarily, the analyst must make estimates based on experience. In addition, the forex markets tend to anticipate events and discount them in the currency value in advance. Finally, serving as both a disadvantage and even as an advantage (depending upon the timing), the markets often take time to recognise that exchange rates are out of line with value.