Six steps to improve your currency trading: Fifth Step

step 5: Be In The Know with Fundamental Analysis

What influences prices in the currencies market?

Traders use fundamental analysis to try to forecast the effect that economic, social, and political events will have on currency prices. Prices in the currency market are affected by macroeconomic factors such as inflation, unemployment and industrial production. Based on the analysis of economic data, traders will take positions on the market with the objective of making a profit.

Finding information about economic data is relatively easy.XE Forex News, for example, provides streaming news and market commentary and is available for free.

Traders should focus on three main macroeconomic factors when analyzing foreign exchange rates:

Interest Rates

Each currency has an overnight lending rate determined by that country's central bank. If inflation is deemed too high, a central bank may raise the interest rate to cool down the economy. Conversely, if economic activity is sluggish, a central bank may reduce interest rates to stimulate growth. Lower interest rates usually depreciate the value of a currency – in part, because it attracts carry-trades. A carry-trade is a strategy in which a trader sells a currency with a low interest rate and buys a currency with a high interest.

Employment

The unemployment rate is a key indicator of economic strength. If a country has a high unemployment rate, it means that the economy is not strong enough to provide people with jobs. This leads to a decline in the currency value.

Geopolitical Events

These key international political events affect the foreign exchange market, as well as all other markets.

Example

In May of 2005, there was growing anticipation that France would vote against accepting the European Union Constitution. Since France was vital to Europe's economic health (and the value of the Euro), traders sold the Euro and bought the dollar; this pushed the Euro down so far that many traders thought it couldn't go any lower.

But, they were wrong. When France actually voted against the constitution, the EUR/USD currency pair fell by more than 400 pips in three days. Traders who bought the Euro lost thousands. On the other hand, traders selling the Euro made thousands.

Be aware that trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.

Source: http://www.xe.com/currencytrading/improve.php

What should you know about Forex Signals ?