Fundamental Analysis (lesson7)

Welcome to the course where we talk about Fundamental Analysis.

We will be getting in mechanics in why prices move and what drives the market over the long and short term.
We learn how detailed understanding of fundamentals can help you build your conviction and why this is vital to your trading.
Forex fundamentals revolve about Central Banks of each nation, and the markets expectation what that bank will do next.
The bank uses economic indicators to determine a state of the economy and implement certain tools to help improve those indicators and keep everything stable.
In this course, we will learn about all of that and learn the whole process of analysing and understanding all the parts why fundamental analysis is so important to forex trading.

We will break this concept of analysis into 2 parts.

• Underlying Fundamentals 
• Sentiment

A simple way to understand this is that Fundamentals is the big picture- things that don't change too often, they are driving the price for week and months and sentiment are short term things that drive price over an hour or couple of days.
Sentiment can drive prices against the trend, but the trend will resume at some point and sentiment will fade.
Understanding this 2 concepts and how they work provides us foundations for identifying various trading opportunities over the trading day.
For example, some traders use short-term sentiment to trade the longer term trend while other trades take advantage of sentiment and trade in line with that to make a quick profit.

The concepts you will learn in this course will give you everything you need to identify the trading that fits you the best, would you like to day trade or position yourself for longer term moves in line with underlying fundamentals.
Fundamentals are very important to successful trading, there are 4 central areas to successful trading that you need to learn to become a profitable trader.
This course will give you something called conviction. Conviction simply means confidence, but traders use conviction to determine how good the trade is and how likely it will win.
If you have very high conviction trade based on all the thing you learned in this program, then chances of your success are much higher.
Traders that do not pay attention to conviction levels or simply or don't know how to increase their conviction have very low chances of success.
You must constantly be aware of your conviction and how to measure and how to control it to achieve levels of success that we are looking for.

We will now look at a concept of Intermarket analysis.
It is important to understand Intermarket relationships and understand our process in this as speculators.
We play an important role to market wich is liquidity and better prices to trade from.
Speculators contribute to all markets and generate movements across of all asset classes.
We will look more deeply in markets in other markets being traded, how we can use this information to profit from it and most importantly how they are relevant to us FX traders.
We will look in the futures market and how this helps us in forex trading.

Main assets that that are important are:

• Bonds
• Commodities
• Equities

So let's start with Bonds.
A bond is simply a form of the loan, so you and I would borrow money from a bank or maybe even family but for the very large company or government, this is impossible because banks are not in a position to lend this big amounts of money safely while keeping their balance book balanced.
So these large entities raise money by splitting that loan between thousands of investors in the open market.

Anyone offering bond to investors is called issuer, in exchange of invest of money the government of the company will pay the money back at certain date wich is know as maturity and to the top of this, they pay to investors interest.
This is also called coupon. Bonds are known as fixed income securities course the amount of money we invest or receive at the end of the loan is known in advance and guaranteed by the issuer.
The coupon is paid twice a year and at the end of the period, the investor receives their original investment back.
For example: if you buy a bond with a face value of a thousand pounds and has a maturity of ten years and coupon of 8%. This means you will receive 80 pounds every year for ten years and then original thousand pounds back.
When purchasing a bond you are purchasing debt.

There are 2 main types of bonds

• Corporate bonds wich company issues
• Government bonds wich are directly in ties with interest rates

Because governments are very dependable and stable, the chances of not paying are very low making bonds low-risk investment.
Because they are traded on the open market you can buy a bond and sell it anytime before the maturity date.
Some people get confused by a price of bonds and the yield on the bonds. When pricing bonds it's important to remember that face value is the price we are returned to investment on maturity and the price of the bond is how much it cost the investor to buy of another investor before that maturity date.
When a bond trading a price above its face value then we are trading at the premium, but when it's trading below its face value then it trades at the discount.
The interest coupon can be based on fixed interest rate that is tied to its face value.
For example: if you buy a bond for a thousand pounds and have fixed rate of 10% you will receive 100 pounds each year not matter what happens to markets or in a case of US treasuries it can be tied to the index.
The price of bonds with lower coupon tend to fluctuate more while higher coupon prices tend to be more stable.

The maturity date can be anything from a day to ten years, and sometimes it can be high as 100 years as in a case of Mexico in 2015 when they launched world's first 100-year bond priced in euros.
The length of maturity will also dictate what price it is because the bond with 1-year maturity is much more predictable then bond that matures in 100 years.
The longer the time to maturity the higher the interest will be. Of corse, this all revolves around risk, higher the risk the higher the coupon will be. To help investors handle this risk there are several bodies that alert investors that find the highest and lowest entities out there.
This help investor makes correct decisions based on their own risk tolerance.
There are several grades that split each issuer into investment grade or junk grade.
An issuer with multiple A rating is the highest quality to deal with while triple B or single A rating are still strong.
Anything that has triple B rating or below is considered speculative and much higher risk.
Governments and their bonds that are rated as Junk are not safe and they offer the much higher yield to tempt investor in.
The most confusing part of the bond story seems to be so many prices to measure, to simplify this I will make it as clear as possible.

The Yield is simply the coupon amount divided by the price of the bond, to understand this better we will use the example to explain it.
Imagine you buy a bond that has face value of thousand pounds and coupon of 10% so if the price remains the 1000 pounds the yield is simply 100 pounds per year, however if the price of the bond goes down to 800 yield now increases to 12.5% because the coupon payment is based on the 10 % of the original face value of the bond. This means you will be receiving 100 pounds for 800-pound bond wich is obviously better than 10%. The reverse is true if the price goes down.
So simply when the price goes up the yield goes down, and when the price goes down the yield goes up.
So if you are in the market for buying bonds your primary concern is the high yield but if you are the bond holder and you have your yield already locked in you want to see a price of the bond increase so you can have the option to cash in for much bigger profit later on.
Bonds are in close relationship to interest rates.
Interest rates are important to the bond market as they are important to fx markets.
When interest rates rise the price of bonds in the market fall, so they raise the yield of the older bonds to bring them in line with news bonds that are being issued with lower coupons.
That's why bonds are so effective by rate adjustments and speculation surrounding them.

So there are 3 types of government bonds

• Bills - that mature in less than a year
• Notes - that mature in 1 to 10 years
• Bonds - that mature longer to 10 years

All of this marketable securities from the US government are collectively known as Treasuries.
US bonds are videly watched in the markets because its safest form of investment avaliable because they are issued directly by US goverment.
Other first world governments are also very safe, the UK for example.
Now because secure nature of the bonds the fact that they provide guaranteed payout they are extremely popular by large investments and pension funds from around the world looking to ensure growth in the safest way possible.
Bond markets relate to FX on 2 main levels
Interest rates and speculation - by watching the bond markets we get clues can similar moves happen to FX.
The other correlation for example during times of increased risk or low domestic yields large funds may decide to invest in the bonds of foreign government.
For example UK pension fund may decide to buy some US tresauries in order to protect them to be overly exposed to UK assets.
So to do this they first need to buy US Dollars to and sell their British pounds in exchange.
So by trading the bond market they first must trade the FX market effectively selling the GBP/USD pair. In very large volumes this can have impact on various currencies and it is very important to be aware of it.

The next asset class that impact currency markets is Commodities

Commodities are the product of nature that can be bought and sold.
Traders most commonly trade commodities by futures contract.
The relationship between commodities and currencies is based on how prices of commodities will impact the overall performance of the economy of nation wich is producing it or importing it.
For example: USD/CAD
Canada is major producer of Oil and if prices fall significantly in small period of time it will start to reduce amount of money Canada makes from oil and it will start to effect on GDP and growth of the country.
If the economy stagnates and inflation start falling then Bank of Canada may be forced to cut its interest rates wich, in turn, will cause the currency to devalue.
So if you are trading CAD dollar it is important to look what is happening to Oil market.
It is important to know wich country is heavy dependant to wich commodities and how much the 

focus is market giving to commodities.

The truth is commodities prices move every day but not all of this moves will impact the FX.
If oil prices fall hard in one session because some announcment from OPEC it may not necceserly cause big moves in Canadian Dollar, howewer if it moves in strong trend and it haves very good reason to continue, for example: over supply, the nation decide not to cut oil production this can lead to more concern to FX markets wich can lead to panic selling wich can rise if there is also negative data from Canada.
So the key is not just to watch the commodities chart or to try trade correlation but to tune into markets reaction and find how serious the reasons are, and how it could impact the nations economy.
The main reason traders are confused by Intermarket analysis is that they try to interpret each move as fixed rule.
For example: if oil goes up Canadian dollar must go up.
The reality is that the most of the time the market may not even look at oil prices.
The market is people.
So your analysis should be sentiment based rather then purely price based for the best results.

Another asset class is Equities - or stocks and shares.
Equities are simply stocks and shares of companies around the world.
Traders use the stock market to see how much market is expecting economy of that nation to perform.
So if they are expecting an economy to do well then the stock market will rally and push higher and another way around.
As with commodities, this is not an exact science because most of the time FX markets trade on their own issues leaving the stock to move their own way.
But sometimes they will become obsessed by some company in the equities market.
For example: maybe there is a big sell-off in the stock market and it moves to FX market and creates panic, crushing both markets.
This is the exact type of scenario that occurs and brings both markets into the spot line.
Stocks can be also impacted by FX.
For example: if a company haves many sites around the world then they will need currency of each country in order to pay their staff in those places. This can have the impact on currency over the short term.
If central bank of that nation decides to implement dovish behaviour and leads to depreciate its currency this can impact the future earning potential of companies that export a lot of products abroad.
Depreciation of this currencies can give this company more competitive edge because the cost of the items is now much less wich lead to more profits wich leads to the higher share price.

As you can see all markets are interrelated on many levels and one does not always lead to other and none of them are necessarily related at all.
But when the market has concern and idea on its mind correlations can be very powerful and can lead to very good trading opportunities.

So you need to use a market reaction to know when to be focused on particular correlation.

Trader Alen