In order to make the right decisions, you have to know the techniques to analyse the market and find the potential profitable movements. This section introduces traders to technical and fundamental analysis in forex trading. In the arena of active forex trading, staying abreast of evolving market conditions and their historical context can be an arduous undertaking. Seemingly endless data sets and news items are constantly in line for scrutiny, with each potentially impacting the eventual success or failure of a specific trade.
KEY TAKEAWAYS
- Forex analysis is the study of determining whether to buy, sell, or wait on trading a currency pair.
- Currencies trade in pairs, with the exchange rates based on the price of one currency relative to the other.
- Major types of analysis include technical and fundamental, with many traders using a blend of both approaches.
Types of Forex Market Analysis
Analysis can seem like an ambiguous concept to a new forex trader. But it actually falls into three basic types.
Fundamental Analysis
Fundamental analysis is often used to analyze changes in the forex market by monitoring figures, such as interest rates, unemployment rates, gross domestic product (GDP), and other types of economic data that come out of countries. For example, a trader conducting a fundamental analysis of the EUR/USD currency pair would find information on the interest rates in the Eurozone more useful than those in the U.S. Those traders would also want to be on top of any significant news releases coming out of each Eurozone country to gauge the relation to the health of their economies.
Technical Analysis
The technical analysis comes in the form of both manual and automated systems. A manual system typically means a trader is analyzing technical indicators and interpreting that data into a buy or sell decision. An automated trading analysis means that the trader is “teaching” the software to look for certain signals and interpret them into executing buy or sell decisions. Where automated analysis could have an advantage over its manual counterpart is that it is intended to take the behavioral economics out of trading decisions. Forex systems use past price movements to determine where a given currency may be headed.
Weekend Analysis
There are two basic reasons for doing a weekend analysis. The first reason is that you want to establish a “big picture” view of a particular market in which you are interested. Since the markets are closed and not in dynamic flux over the weekend, you don’t need to react to situations as they are unfolding, but can survey the landscape, so to speak.
Secondly, the weekend analysis will help you to set up your trading plans for the coming week, and establish the necessary mindset. A weekend analysis is akin to an architect preparing a blueprint to construct a building to ensure a smoother execution. Tempted to trade without a plan? Bad idea: Shooting from the hip can leave a hole in your pocket.
Technical Indicators
If you have opened your trading platform, you will have definitely seen a technical indicator before. For clarity, let’s divide them into two big groups – trend indicators and oscillators.
- Trend indicators – moving averages (MA), MACD (Moving Average Convergence Divergence), ADX (Average Directional Index) or Ichimoku – point out the direction of a trend (but not always the direction of the current price action) and the strength of the trend.
- Oscillators – RSI Indicator, Stochastic, or the Parabolic SAR Indicator – point out the turnarounds.
Trend indicators work well in trending markets, whereas oscillators work well in ranging markets. At least they do in theory. There are a couple more that are in between, such as Bollinger Bands. They use both a variation of an MA to track the trend, as well as the price range channel to hint on the turnarounds.
Finally, there are volume based indicators. These are interesting because although trading volume has always been used in financial trading as a defining factor for supply and demand, accurately measuring it within a Forex spot market is impossible. This is because Forex spot is an OTC (over-the-counter) market.
Technical indicators are, for lack of a better word, imperfect. They lag behind the price, often being redrawn upon the candle closing. They are used regularly in combinations to complement each other, because otherwise they fail completely. And when you hear professional traders advising beginner traders to keep their charts clean and simple – they are talking about not abusing the technicals. Lastly, trading strategies that are based purely on technical indicators can hardly provide a competitive edge.
Economic Theories and Raw Data
Besides the market sentiment, there are also a few economic theories that work on locating disparities in the current price of a currency and its ‘true’ value. Here are a few examples:
- Purchase Power Parity (PPP) – assumes that goods should cost the same after the currency rate adjustment. If they don’t, good trading opportunities present themselves.
- Interest Rate Parity (IRP) – basically the same as PPP, except that goods are financial assets in this case, and their purchase in different countries should yield the same after the interest rate adjustment.
- Balance Payment Theory (BPT) – deals with a country’s trade balance. If more goods and services are imported than exported, the national currency will depreciate.
- Real Interest Rate Definition Model (RIRDM) – exactly the same as IRP. A currency with higher interest rates will appreciate against the currency with lower rates, through being a more attractive investment.
- Asset Market Model (AMM) – much like the trading balance, except that measures inflow and outflow of foreign investment. The more foreign investment, the higher the national currency appreciates.
Aside from the aforementioned theories, raw national economic data has a say in Forex weekly analysis. Employment data, interest rates, inflation, GDP (Gross Domestic Product), trade balance, retail sales, durable goods and other indicators all can have a short term effect on the market upon their publication. If you would like to track this sort of data, you can do so with our Forex calendar.
What type of analysis is better?
Forex trading is all about trading based on a strategy. Forex trading strategies help you gain an insight of the market movements and make moves accordingly. We have already studied that there are three types of analysis methods.
- Technical analysis
- Fundamental analysis
- Sentiment analysis
Each strategy holds equal importance and neither can be singled out. Many traders and investors prefer the use of a single analysis method to evaluate long-term investments or to gain short-term profit. A combination of fundamental, technical and sentimental analysis is the most beneficial. Each analysis technique requires the support of another to give us sufficient data on the Forex market.
These three strategies go hand-in-hand to help you come up with good forex trade ideas. All the historical price action (for technical analysis) and economic figures (for fundamental analysis) are there – all you have to do is put on your thinking cap (for sentimental analysis) and put those analytical skills to the test.
In order to become a professional forex trader, you will need to know how to effectively use these three types of forex market analysis methods.
- 10 Market Indicators You Need in Forex
- 5 Easy Ways for Global Cues for Better Trading
- Exotic Forex Indicators
- Finding Trends: Use of Moving Averages
- Forex Moving Averages Explained
- Fundamental Analysis Explained
- Housing Starts – Forex Trading Indicator
- How QE Tapering Can Affect Your Forex Trading
- How to Calculate Bollinger Bands?
- How to Trade Trends Within or Against the Trend
- Learn How to Draw Trend Lines Correctly
- Monetary Approach to Determine Exchange Rates
- Rate Of Change (ROC) in Forex Technical Analysis
- Selecting the Best Trading Tools for Forex
- Trading with Bill Williams Indicators
