Turning Point and Fundamental Data in the Forex Market
The foreign exchange market, also known as the Forex market, is a global marketplace where currencies are traded. Currencies are important because we need them to purchase goods and services locally and across borders. There is no central marketplace for the Forex market. The forex market is the largest financial market in the world. It is even bigger than the entire US stock market. There are various participants with different purpose trading currencies in the Forex market. The participants in the Forex market include banks, international companies, hedge funds, money managers, tourists, and individual investors. Just like the price of a stock, the price of a currency is fluctuating every day. The price of a stock is often affected by the intrinsic value of the company and the national economic conditions. However, the price of a currency is affected more with national economic conditions. Hence, the value of a currency can rise and fall when the following economic data are released.
- Economic indicator (e.g. Gross Domestic Product)
- Employment indicator (e.g. Unemployment rate)
- Inflation indicator (e.g. consumer price index)
- Interest rate
- Decisions and announcements from the central banks
- Changes in political and financial regulations
- And so on
As in the stock market, these economic data play some important role to reduce any irrational movement in a currency price. Let us take a look at the interest rate example on EURUSD, the Euro to Dollar rate. The interest rate is considered as an important variable moving a currency price. To find out any adverse effect of the interest rate to EURUSD, we can graph the interest rate difference between USA and Germany against the EURUSD rate. We can observe the mean reversion effect whenever the gap between the interest rate difference and EURUSD rate is large. Simply speaking, the EURUSD rate tends to go back to the fair value whenever the market value is highly deviated from the fair value.
Figure 2-2: EURUSD vs Short Term Interest Rate Difference between USA and Germany (Chart: Bloomberg)
Interest rate is one of many economic data in the Forex market. Besides, many other economic data, like the consumer price index, unemployment rate, trade of balance and so on, can move a currency price in the similar manner. In our trading, we need to watch out the influential economic data. Then, we can identify the currency with the high margin of safety in regards to this influential economic data. As in the stock market, the release of these economic data can affect the forex market in short and long terms. Sometimes, the released economic data can create the turning point during the day. Sometimes, the released economic data can create the turning point in several weeks. The turning points occur to accomplish the mean reversion whenever the currency is overvalued or undervalue too much to the fair value. Sometimes, the government does not like the currency price to move too high or too low. They can take some actions like the quantitative easing, interest rate change, setting up new regulation and so on. As the result of the government actions, the mean reversion process can take place after the price makes the turning point.
As in the price mechanism illustrated with the value investing, the economic data in the Forex market drive the currency price in the similar manner. The economic data provides the ways to describe the intrinsic value of the currency in the Forex market. The bullish turning point and the bearish turning point will occur whenever the spread between the market value and intrinsic value is too high, in fact, it is the absolute spread. This also provides one of the explanation to why price moves in the complex zigzag path and why we get to see many price patterns in the market.
About this Article
This article is the part taken from the draft version of the Book: Science Of Support, Resistance, Fibonacci Analysis, Harmonic Pattern, Elliott Wave and X3 Chart Pattern. Full version of the book can be found from the link below:
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