What moves the market?

The fundamentals of FX

Interest rates, oil prices and non-farm payroll – few markets are as sensitive to big macro themes as FX. And staying on top of so many variables can be tough. But exactly what data do FX traders need to watch, which fundamentals really rock the euro and why do technical analysts so fiercely champion the chart?

'Generally FX moves are caused by interest rates, fundamentals and technicals' says Deutsche Bank's Russell LaScala.

But what is unique about FX is the political factor, he says. Big moves in a currency can trigger political pressure on a central bank to intervene. This does not happen with stocks, bonds or commodities, he notes.

'The FX market is moved by the difference between expectation and reality,' says Saxo Bank's Tom Nagle. 'Players within the market have their expectations on how economies will grow, and there are various assumptions surrounding these expectations, mainly based on central bank actions and rhetoric.

'If the central bank actions are perceived to be out of kilter with the market's view thenthe market will move.'

Watch with interest

The fundamentals which most affect FX are interest rates, perceptions of whether individual corporate bonds are ahead or behind the curve, rates of unemployment, manufacturing data and retail sales, he says.

Certain things also come in and out of vogue, he adds. For example the oil price, the perception of equity markets, non-farm payrolls– especially between 2003 and 2006 –and the credit squeeze, as seen currently.

'Investors in FX need to have an awareness of many things, including data releases due in today's session, which ones are deemed to be the market movers and the implications if the data are far away from the consensus view,' Nagle says.

'They should have a general technical picture in their mind about the markets they're trading in, whether the market is bullish or bearing and what would be required to change that scenario. Also, knowledge of the previous session is very helpful.'

Some currencies – for example the Australian, Canadian and New Zealand dollars– are particularly sensitive to commodity prices. 'But outside of those currencies, interest rates are most important – that is the number one thing that people should be looking at,' says Drew Niv at FXCM. 'If you can predict interest rates correctly, you can predict FX.'

'The biggest driver or motivation for why people trade FX is interest rates,' says LaScala. 'Currently we are in a very low US interest-rate environment, with a higher interest-rate environment in Europe, which accounts for the rise in the euro-dollar.'

Investors also need to be aware of what's happening to share prices, argues E*Trade's Phil Sisca. 'In general, if equities start to fall, we see a movement back into the low-yielding currencies – the yen and the Swiss franc, and then everyone wants to sell the high-yielding currencies against them.'

Compared with trading individual equities, tracking the fundamentals that affect FX involves a lot of work, which is part of the reason behind technical analysis' popularity, he adds.

Time to get technical

Technicals take some of the complication out of trading FX, agrees CMC Markets 'James Hughes. An investor trading cable on fundamentals for example needs to factor in everything that's going on in the US –from equity markets to monetary policy and recession fears. 'And then you have to think about everything that's going on in the UK as well. You have to double the fundamental data up.'

'Technical analysis is a way of assessing crowd psychology and taking advantage of it,' says Nagle. 'It can show you where the crowd sees value, and which direction they are likely to move.'

Most traders use technical analyses of some type, but approach it in varying ways, he says. 'Some will only use it as a timing tool to enter trades which they have preselected on a fundamental basis while others will trade 100% off the technical indicators.

'I use technicals almost 100% of the time,' Nagle adds. 'I don't have any time for those who talk about self-fulfilling prophesies. Technical analysis works, full stop. Even the old-school traders who have scorned it in the past cannot expect to survive without it, even if they will not admit to using it.'

Technical analysis helps in controlling a trader's risk, in pre-planning their parameters and also acts as a road map, says Sisca. 'The charts are your maps – they guide you and tell you what to expect,' he says. 'If you're new in a place and you don't have a map with you, you're at a disadvantage. Technical analysis defines your entry and exit points for you,' he adds. 'You have general opinions – what the dollar's going to do, or long-term prospects for the dollar– but in order to get in and out, and time your trades properly you need to have your technical analysis tools.'

Within technicals, FX traders tend to use moving averages, range highs/lows, momentum indicators, retracement levels, trend lines and channel break-outs. Some traders use Bollinger Bands, Linear Regression or more complex approaches such as Ichimoku and Elliott Wave Theory, 'but simplicity goes a long way in my opinion,' Nagle says.

Technical analysis tends to work better with FX than with any other asset class, and this again comes down to its volatility, says Hughes. 'Because you get the bigger moves, you tend to get clearer buy-sell signals.'

The fact that FX markets tend to trend also makes technicals work well, argues IG Index's David Jones. And with so many traders relying on technicals for FX, the system is given extra momentum. 'If a big level breaks on a chart, there are more people watching that level on currency markets than other markets. So it will have more of an impact.'

The removal of an extra layer of unknowns makes FX better suited to technical analysis than are equities, says Niv. 'They are less prone to things like a CEO committing fraud,' he says. 'It doesn't have those things that charts can't predict.'

Tooled up

Ultimately though, there is no easy answer to investing in FX – and few traders would step into the market without solid fundamental research plus a taste for technicals.

'Does FX move with fundamentals or technicals? Well it's both,' says Sandy Jadeja at ODL Securities. 'For the longer-term approach, fundamentals are key. But for the short-term approach to intermediate term, technicals win hands down.'

Retail investors need to decide first whether they're approaching the market from short- or long-term perspective, which means they also have to decide whether they're playing the spot market or the futures market, he adds.

'The spots will be very short-term traders, and the forwards would be trading everything from a couple of days to maybe even a couple of months.'

While technicals work well for short-term and momentum trades, fundamentals rule for longer-term plays, agrees Jones.

'The vast majority of decisions in financial markets are not being made off charts,' he says. 'Certainly, technicals play a part. But ultimately, what makes FX a good market to trade is the fact that everything affects it.'

©Taken from Shares Magazine Forex Feature 2008.