Fundamental Analysis

Let's say China needs a lot of steel. And they sign a new contract with a company in Australia that makes steel. Theoretically, the share price for that Australian steel company should go up. You read about that deal in the newspaper, then call your broker and buy some of that company's shares. That's a trading decision based solely on fundamental analysis.

Another example might be that the company hires a new CEO, and that CEO did very well for the last company he/she worked at. You'd expect the share price to go up.

If a company is expected to announce $5m in profit for the year, that's also a good thing. So the share price should go up. But if actually everyone was expecting $10m in profit, turns out $5m in profit is not so good, so the share price will go down. It's not that $5m in profit is actually bad - it's that it's bad compared with peoples' expectations.

This is the bit that makes fundamental analysis a little tricky - not only do you need to know about the company, you also need to know what other traders' expectations are about that company. If everybody already knew about that deal between China and the Australia steel company, it has already been factored in to that company's share price. Buying when you read about in the newspaper is probably too late.

For currencies, there are a range of things which make the price fluctuate, which normally revolve around the flow of money.

Think of a currency like any other commodity - it responds to supply and demand. Too much supply and the price goes down. Too much demand and the price goes up.

Demand increases when people want to move their money into that country.

A simple example is when you travel to a country, you exchange your money into that local currency. What you've done is sold your currency and bought the local currency. If there was a natural disaster almost wiping out the tourism industry, less people want to travel there, so less people will want to buy the local currency, so it becomes weaker.

When a country's interest rates go up, so too does the interest that banks give on deposits. With higher bank interest comes more money flowing into the country, i.e. more people want to buy the local currency. That's good for that country's currency, and so it becomes stronger.

When a country's economy is strong, and an announcement is made by a government agency that it's going to get stronger, more people will want to invest in that country. Once again, they want to buy the local currency, so it becomes stronger. The Non-farm payrolls (NFP) announcement seems to shake things up a lot - a good announcement means the economy is doing well.

However, it's one thing to know what should happen, or to know why a price is going up or down. It's another thing completely to take advantage of that knowledge.