Economic fundamentals can be confusing since there are just so many things to watch and keep an eye on. But to make it simple just follow the money. Where the money goes so does the economic strength. The money is in two parts trade flows and capital flows. These two things combined are known as the balance of payments, and this indicates supply and demand for currencies.

Trade Flows:

Trade flow is the difference between imports and exports. Japan is a net exporter, they export far more than they import. Since foreign corporations have to buy their products with the Japanese yen, this creates a natural demand for their currency. The United States is a net importer which causes the American Dollar to flood the world markets which ultimately weakens the USD.

Capital Flows:

Any market which is considered the "hot market" of the time will attract investors worldwide and create capital flows into that country. This capital flow will create a demand for the currency which will cause it's value to rise. Rising interest rates have a huge impact on capital flow, because fixed investments such as bonds become more attractive to foreign investors. This is why changes in interest rates are watched so closely in the Forex community. Undervalued real estate also attracts major foreign investors which creates a currency demand.  Let's say an investor in Europe wants to buy real estate in the United States, they have to change all of their Euros into U.S. Dollars before they can buy the property in the U.S.A. and this creates a demand for the USD.

Balance of Payments:

The balance of payments is the balance between capital flows and trade flows. This is also how the United States gets away with being a net importer. The US trade imbalance (trade flow) is offset by Asian central banks investing back into US treasuries (capital flow). If the Asian banks didn't invest in the US dollar their currency would strengthen, the US dollar weaken and exporting goods would become more expensive.

So how do we know about these trade and capital flows?

The government is kind enough to release several reports, some monthly, some quarterly, that give very clear indications of how a country is doing. The sectors most important for understanding growth and the health of an economy are employment, manufacturing, retail sales, inflation, gross domestic product, and consumer confidence. As a general rule higher rates mean that the economy is strengthening and that interest rates may soon rise.

This is a very simplistic overview of the fundamentals when studying countries for currency investment. For more in-depth information on which reports to watch for read the news trading section.