Fundamental analysis is considered to be the holy grail of stock investors. Warren Buffet claims to have amassed his fortune thanks to it. People who consider him to be a role model swear by the effectiveness of this method. The media also cannot stop singing praises.
However, ask any Forex trader whether they follow fundamental analysis and the answer will be a resounding no. We are not talking about self-proclaimed experts here. Although a lot of them will also agree with this opinion. However, since they may not be considered to be qualified enough by the general public, their opinion probably doesnt count as much.
We are talking about guys that trade for Wall Street giants like Goldman and Morgan Stanley. Apparently, the Forex market as a whole does not seem to believe much in fundamental analysis. It may be the only financial market where participants are emphatically against the belief that fundamental changes is what drives their market. This leaves Forex traders without the holy grail of fundamental analysis which is used by traders worldwide. That is what makes Forex trading incredibly different and unique as compared to other financial markets.
In this article, we will analyze the top five reasons as to why fundamental analysis does not work in Forex markets.
Stock markets are limited to one or a few economies. For instance, the FTSE is largely affected by the economic developments within the geographical boundaries of Great Britain. However, the Forex market is an international market. It is affected by the economic and political developments across the entire world! Hence, an infinite number of factors come into play.
It is simply impossible to even list down all the factors that affect the Forex market, let alone track them and make decisions based on them. Forex traders, through trial and error, know that fundamental analysis is an extremely time consuming activity which provides little to no benefit in the long run.
Out of Date Data
Forex traders make decisions based on data released by countries. They track the unemployment data, inflation data, and productivity data and so on. However, countries only release this data with a lag of three to six months.
There is no possible way to release this data in real time so that traders can take decisions accordingly. Therefore, by the time this data reaches the market it has already become obsolete. Hence, if decisions are made based on obsolete data, they are bound to lead to a loss.
Politicians gain or lose their jobs based on the data regarding unemployment, inflation etc. Hence they have a strong vested interest to manipulate the data to make it appear like they are doing a good job. Countries like China have been famously manipulating their data to obtain foreign investments.
Stock markets have auditors to ensure that the data released to the public is genuine. However, no such compulsions exist for Forex markets. Data manipulation is therefore rampant. Also, there is a high degree of inconsistency as to how these numbers are calculated across different countries. Fundamental analysis based on data which is fundamentally incorrect is inappropriate to say the least.
Market Always Overreacts
Forex markets always react fast and they over react. A currency that could have been considered to be undervalued if fundamental analysis was somehow able to provide that inference would suddenly shoot to the top. Forex markets runs in circles of greed and fear.
The market gives a ferocious response when it finds that the currency is either overvalued or undervalued. Hence, fundamental value is merely a bookish number. It is not like the value of the currency will finally settle at that number. Also, the fundamentals of any currency keep changing from moment to moment.
Hence, unlike companies the fundamentals of countries themselves are not static. Keeping a theoretical number as the basis for your trades may not be a good idea since the market may never really settle at what is often referred to as the equilibrium point by the proponents of fundamental analysis.
Timing Not Revealed
For once lets assume that you were to actually decipher the complex code of the Forex market. You somehow figured out that the Euro is overpriced compared to the dollar. This means that the Euro should correct itself through a decline in its price against the dollar. However, the key question is when is this decline going to happen? The answer is nobody knows.
Fundamental analysis, at the maximum, may reveal that a particular currency is overpriced or underpriced. However, almost all bets placed in the Forex markets use leverage. Leveraged bets have an expiry date, you cannot hold them for decades as Warren Buffet famously claims.
Hence, even if your place a fundamentally correct bet at the wrong time, you are going to lose money. The interest being charged and the accumulating mark to market losses will most likely force you to unwind your position and book losses. On the other hand, if one were to simply avoid leverage so that holding the bets for decades did become an option, the percentage gains and losses would be so small that conducting the fundamental analysis would turn out to be a futile activity.