FUNDAMENTALS
Fundamentals are simply understanding the reasons why the market is moving rather than just identifying that the move has happened.
​
When we understand why something is happening we have more confidence in what we are doing and if we can interpret what the market is thinking we will have a better idea of what might happen next.
​
All professional traders pay a lot of money for up to the minute fundamental news from places such as the Bloomberg terminal, which works out at an annual cost of $24,000!
​
This clearly shows that fundamentals are a key part of a successful trading strategy and can’t be over looked.
​
Our focus for this fundamentals chapter is central bank. The definition of a Central bank is “a national bank that provides financial and banking services for its country's government and commercial banking system, as well as implementing the government's monetary policy and issuing currency.
​
Central banks are accountable for the a lot of the moves within the Forex market. We take studying and researching these central banks very seriously.
Central Banks
​
The Eight major central banks of the world are:
​
1 US Federal Reserve Bank (USD)
2 European Central Bank (EUR)
3 Bank of England (GBP)
4 Bank of Japan (JPY)
5 Swiss National Bank (CHF)
6 Bank of Canada (CAD)
7 Reserve Bank of Australia (AUD)
8 Reserve Bank of New Zealand (NZD)
What do central banks do?
​
A central bank is an institution responsible for the setting of the country’s monetary policy. Their job is to make sure the economy is stable and growing. All developed nations have a central bank and all actions of the banks directly influence the price movements of the countries currency.
​
Everything they do impact the trades we take, all we really need to understand is what the banks are thinking at any given time. If we know what they are thinking; what they are happy with, what they are unhappy with, then we can use that information to predict what they are going to do next. These actions will move the price of the respected currency.
​
We will now look into the 8 major central banks in detail.
Federal Reserve Bank of United States
The Federal Reserve is the most influential bank because the US dollar is the most heavily traded currency. The Federal Reserve’s Federal Open Markets Committee (FOMC) meets to set interest rates and is made up of 7 governors of the Reserve Board and 5 of the 12 district reserve presidents.
​
The Federal Reserve meets 8 times a year. Twelve regional Federal Reserve Banks were created so that the economic operations of the United States could be monitored efficiently. The FOMC committee meets about every six weeks.
​
The decisions made by the FOMC are closely watched by investors both within and outside of the US because it gives traders an idea of the economic sentiment, which can be used to predict possible interest rate movements. The Federal Reserve Bank’s main focus is to achieve long term price stability and growth just like the ECB.
The European Central Bank
​
The European Central Bank was established after the creation of the Euro in 1998.
​
The European Central Bank has a group similar to the Federal Open Markets Committee that helps decide on the changes that may need to be made to monetary policy.
​
The committee is known as the Governing Council and is comprised of 6 members of the executive board of the European Central Bank in addition to all the governors of the national central banks from the countries which use the Euro.
​
The Governing Council meets twice a week but only changes policy at 11 of these meetings each year. The ECB also prevents the currency strengthening excessively as it has a negative affect on the export market.
​
In general their annual target for Consumer Price Index growth is about 2%.
Bank of England
​
The Bank of England consists of a committee known as the Monetary Policy Committee (MPC). It is comprised of 9 members, which include a governor, 2 deputy governors, 2 executive directors and 4 outside experts.
​
The Monetary Policy Committee meets once every month in order to discuss any policy changes. It has the reputation of being one of the more effective banks in maintaining
​
monetary and financial stability. Similarly to the ECB, the Bank of England have an
​
inflation target of approximately 2%.
The Bank of Japan
​
The Bank of Japan also has a committee that consists of the governor, two deputy governors along with 6 other members.
​
It meets once or twice a month and their top focus is to control inflation. The have an active interest in preventing the Japanese Yen from strengthening excessively as they are dependant on exports. They can be extremely vocal when concerned about excess volatility and the strength of their currency.
​
Again one of their main focuses is to maintain price stability.
​
The Swiss National Bank
​
The Swiss National Bank has a very small committee that consists of just 3 people and is typically more conservative as far as interest rate movements are concerned.
​
The committee meets quarterly and as the Swiss economy it is very dependant on exports they have a particular interest in preventing the Swiss Franc from strengthening excessively. Investors love the Swiss National Bank because its a very stable currency to invest in.
The Royal Bank of Canada
​
The Bank of Canada also has a committee which is known as the governing council.
​
The governing council consists of the governor, the senior deputy governor and four deputy governors. The committee meets about eight times a year and have an inflation target of 1-3%.
​
The Reserve Bank of Australia
​
The Reserve Bank of Australia consists of a monetary policy committee which consists of the governor, deputy governor, the secretary to the treasurer and six independent members appointed by the government.
​
The committee meets about eleven times a year, they ensure stability of the currency and have a particular focus on maintaining a good employment rate. They have an inflation target of 2-3% each year.
​
The National Bank of New Zealand
​
The National Bank of New Zealand has no committee.
In fact, all the power of monetary policy lies in the hands of one individual: the central bank governor.
​
The decision is made about eight times a year by the governor, who works hard on maintaining price stability and has a key inflation target of 1-3%.
Central banks decision makers
​
All these major banks have fairly similar structure and mandates. They are made up of a number of people who are in charge of agreeing on appropriate monetary policy going forward. There is a head or chief mouth piece for the banks, this is who the markets pay close attention to. Then there are board members who work alongside the head or chief mouthpiece. The board members are there to propose policy and vote, the proposed policy then gets implemented.
​
Any speeches or comments made by these board members are important to the market because they have an active say on what the future monetary policy of the bank should be.
​
Each member has what is known as a bias. This means they favour a particular type of monetary policy. Some of them prefer to keep interest rates low (known as doves) while others think interest rates should be high (known as hawks).
​
The key to profiting from this information is looking out for comments from hawks and doves which go against their bias. So if a hawk made a speech whereby he mentioned that a rate cut would be a good idea, the market will react significantly because they are traditionally someone who favours rate hikes. This is usually a good indicator that a change is going to happen.
​
So its important to do your research into these board members and know their bias to interest rates.
Central banks use economic indicators which indicate which parts of the economy are
​
doing well and which need input from the bank. Because we know that the banks are using these indicators and acting on the results of them, we need to do the same in order to have our “edge”.
What will Central banks do?
​
We now look at what central banks can do and how they can turn an economy round using the tools they have at their disposal:
​
The most important tool they use is Interest Rates
Interest Rates are predominantly used to control inflation. If inflation is increasing too fast, banks will raise interest rates which encourages people to stop spending and start saving their money which reduces the rate inflation goes up at. On the other hand if inflation is very low and falling the bank will cut interest rates which will discourage people from holding money in savings accounts and encourages people to spend. It also incentivises people to borrow more money which they invest and in turn gets the economy going again. Interest rates are important because anything which indicates that the bank may change their rates will be great opportunities to profit off.
Central banks also use Central Bank language
Central bank language is simply the things the bank says rather than what it actually does, by making these statements about what it would like the market to do and where it would like the pice of it’s currency to be, the bank hopes that the market will take the message as a sufficient threat of action and trade in line with it. Credibility is so vital to a central bank, the market must believe that the bank will step in and act and not just make empty threats. Its important to focus on key trigger words, these changes seem minor but are really important to look out for when doing your research.
The next tool they use is Price Controls
Price control is when the bank tells the market that it desires the currency to be at a specific level sometimes the bank just communicates this and threatens to act if he price moves to far away from the target. Other times the bank will provide a very specific price level and make it clear each time the actual price looks like breaching the specified level it will physically step in and makes sure it doesn't. Central banks will literally buy or sell up a pair and will generally always win any battle.
The most extreme tool central banks have at their disposal is Quantitative Easing
Quantitative Easing is the process of central banks printing money and injecting this money into the financial system, this stimulates growth and investment and also devalues the currency which further supports growth as exports become more competitive. Quantitive Easing is extremely effective, so when a bank threatens to use this the market reacts quickly.
​
Many banks use this as a last resort.
​
You only need to focus on what the bank is concerned with at the time.
If you focus on the indicators that the central banks are concerned with, you will then know what the banks are thinking on a daily basis and when we do this we can actually predict what tools the bank may use and what their plans are. To do this we have to research those exact things.
Your research should start on these website below:
Central Bank News - www.centralbanknews.info
Bloomberg news - www.bloomberg.com/topics/currency
FX Street - www.fxstreet.com
Forex Live - www.forexlive.com
These sites contain key information from market leading analysts.