Forex Fundamental Analysis
Forex trading is a fundamental or technical game, depending on the trader. Technical traders see fundamental traders as people who have not been guided towards the correct path.
Likewise, fundamental Forex traders complain about technical traders of being too caught up in the minutiae. However, the reality is that both methods are quite useful and complementary when it comes to Forex trading.
Now, if a trader chooses to look at the fundamentals of a Forex pair, a very important data point is certainly the Purchasing Managers Index – known as the PMI. And understanding what it is, how it works and its importance in Forex trading can be paramount for anyone who wants to be a successful Forex trader.
Purchasing Managers' Index
The term may sound like it requires an advanced level of understanding in economics or finance. But in reality, all that the PMI does is show the state of the service and manufacturing sectors on a monthly basis. The reason why it is called the Purchasing Managers' Index is that, if seen by purchasing managers, it indicates whether or not the market conditions are prime for a boom or a bust. Therefore, that helps them shape their decisions regarding the health of the economy.
Let's dwell slightly more in-depth into how the PMI works. As previously stated, the report is released monthly by different institutions in different countries/economies. The Institute for Supply Management (ISM), which has over 300 nations as members and was formed in 1915, and Markit are the two largest institutions to prepare this index. So there is a guaranteed that regardless of which pair a trader may be looking at, PMI reports are showing the overall health of the economies of these countries.
For anyone interested in reading a PMI report, it is quite simple. A number between 0-100 represents the state of the economy in comparison to the previous month. So, a number below 50, is a sign that the economy is contracting. And anything over 50 indicates the opposite – that the economy is expanding.
The Fundamentals of PMI
Understanding how the PMI works and where it comes from is a great first step towards using it in Forex. However, it is relevant to know how all that data relates to Forex trading.
A trader living in the US or trading a US pair has noticed that once a month the greenback is prone to volatility around 10:30 and 11:00 EST. The reason for it is simple. GDP data is released quarterly, so there is no sure way to know how are the macro-indicators are going to turn out. However, thanks to the monthly nature of the PMI, traders gain a glimpse of the current state of the economy. And it is between 10:30 and 11:00 EST that the PMI report is released. Beware, the PMI doesn‘t have a 100% correlation to GDP, but, along with Non-Farm Payrolls and other economic indicators, it helps forecasters to accurately predict economic growth.
Economic expectations matter when doing fundamental Forex analysis. If the PMI increased compared to the previous month, then that currency will likely rally. Conversely, if the PMI is lower than the previous month, then that currency is prone to shrink.
Overall, the PMI is a simple but effective tool that greatly helps in fundamental Forex analysis and forecasting exchange rates of currency pairs.