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Trading forex on fundamental data

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Is it possible to trade on fundamental data? Some are highly sceptical about it, call it funny-mentals … The key problem seem to be timing the entry and measuring stoploss levels. Fundamentals may tell that the financial instrument is ¨cheap¨ or ¨undervalued¨, but it tells nothing about entry points. The fact that something is cheap doesn´t mean that it can´t get even cheaper. If somebody buys something based on fundamental analysis and the price goes down, the lower price makes the buy argument stronger while the account carries unrealised loss.

Common wisdom tells that trading forex on fundamental data is almost impossible. Too many factors at play, some of those hardly measurable – the noise is likely to be too overwhelming and the probability of mistake so high that any findings are rendered useless.

Nevertherless, we find one simple fundamental model fairly reliable predictor of exchange rate. The model analyses the interaction of several fundamental factors such as GDP growth, inflation, money supply to project exchange rate direction. The rationale is that, although the exchange rates may divert from the fundaments to a great extent, sooner or later the exchange rates will correct to reflect the fundaments of the underlying economies.

This particular fundamental model has been noticably precise. It needs some non-fundamental, technical input to identify entries and exits, but it is a great tool to improve the odds of long-term trend-following trade being profitable.

Attached here is a reseach summary back in Y2008 calling for ¨doomed GBP¨. The chatter was positive for the cable at the time and there was little to suggest a sharp downtrend in GBP. The rest is history.

Empirical evidence suggests that this fundamental analysis model can be applied to predict long-term currency moves. Yet, conventional technical analysis is required to identify entry and exit price levels.

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Written by A.S.

February 23, 2011 at 8:36 pm

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