Forex Analysis Basics
Fundamental Analysis & Technical Analysis
The million dollar question that every trader tries to answer, that the entire market is revolving around is: Which way will the price go? OR What is the exchange rate for the pair I’m trading going to be tomorrow?
Essentially, figuring this out is the largest part of trading FX. Knowing which way the price will go will determine how much profit you make.
There are essentially two schools of thought that work at trying to fathom this million dollar question. One thought is called the Fundamental Analysis and the other is called the Technical Analysis.
If you remember, in the ‘What is Forex Trading’ article, we compared countries to companies and currencies to their stocks. Essentially, we take the currency to be an indicator of how well the economy is doing.
When the country’s economy is doing well, its currency appreciates in value with respect to other currencies and traders consider it to be a ‘safe’ currency to buy. However, when an economy is not well the currency also tends to drop in value.
Thus, Fundamental Analysis looks at the basic condition of an economy in order to determine whether the price will go up or down. And since economies are affected by political, social, and natural events, all of these together form the basis of Fundamental Analysis.
Fundamental Analysis - Summary
To sum it up: Fundamental Analysis concedes the importance of economic, political and social events; natural calamities; man-made disasters and other global events and their implication in order to determine whether a country’s currency will appreciate or depreciate.
Technical Analysis is clearly, technically inclined. Technical Analysis is about studying past trends in prices and market movements and identifying a pattern or a trend with which you think you can predict with confidence.
Essentially Technical Analysis presumes that economies follow a cyclic pattern regardless of economic/social/political/misc factors, much like technical analysis in the stock market. These patterns also affect their currencies and thus it is possible to find trends in currency movements which will repeat themselves.
In order to figure these trends out, traders make use of different types of charts which fall into one of these three categories:
• Line Chart
• Bar Chart
• Candlestick Chart
By learning to interpret these charts, it is possible to determine how the currency will move.
Which Method Should You Choose
Throughout your trading life, you will meet traders who will swear by either method. Often, you will also find yourself wondering which one is the best forex trading method. Truth be told, you need to know both.
This is because although at a ‘gut’ level fundamental analysis makes sense, there are too many events happening around the globe. It is very difficult to pinpoint which of these events will affect your trading pair and in what manner. At such time, technical analysis gives you factual data to go by.
At the same time, trends and patterns don’t exist in isolation. It would be ridiculous to assume that a trend will repeat itself regardless of current economic/social/political conditions. Thus, a marriage of the two schools is what you need to look at for the long term.