Forex Market analysis will only be helpful to you if you know how to interpret and use it. For a beginner, one of the most critical steps is understanding the different analysis tools and how to use them. To ensure that you are using market analysis effectively, here are the main factors you need to keep in mind.
Understand the Drivers
Other forces typically drive market trends. Successful traders look beyond the trend to understand what is causing the market to react in a particular way. For instance, if investors are predicting an upswing, the result in the market would be a rebound or recovery that would, in turn, translate to the strengthening of a particular currency.
These drivers are essential when predicting how a particular currency is likely to move in the future. Do not just stop at the trend but try and understand the drivers behind the trends in the market.
Chart the Indexes
Since forex trading is done in pairs, one of the critical things you need to understand when trading forex is how two currencies relate to each other; one way to do this is by charting the indexes of both currencies. These indexes will help you determine whether currency pairs are positively or negatively correlated. A positive correlation indicates that the currency pair moves in the same direction, while a negative correlation means that the currencies move in opposite directions.
Currency pairs like the EUR/USD and GBP/USD are often positively correlated because closer economies are more likely to move in tandem. Ultimately the type of correlation between currency pairs affects the potential for profit or loss on a particular trade.
Time your trades
One of the essential aspects that forex traders need to master is how to time their trades. For example, if you predict potential turning points in the trend based on your analysis, you can choose to make shorter moves to avoid the risk of unexpected fluctuations in the market. On the other hand, if your analysis shows that the trend is likely to hold for a while, you can opt for extended holds. Your analysis should guide you on how to time your trades best to make the most out of your investment.
Fundamental Forex Market Analysis
Fundamental analysis is the process whereby a trading strategy is developed and then influenced using items of news and information which directly impact economic activity.
The principle behind this type of analysis is that when a country’s economy is doing well, this success should generally be reflected by an equally strong currency.
Similarly, when a country’s economy appears to be performing less well, this is likely to result in a weaker currency. The relative change that this economic strength has upon economies and currencies subsequently forms the basis for speculative trading.
The information that forms the foundations for this economic data is fundamentals. Fundamental data encompasses many scales, from macroeconomic news to far-reaching global events to localized national economic information. The ultimate aim of fundamental analysis is to use it to try and determine how specific news, reports, and data releases will influence the currency markets and determine what trends may appear as a result of these releases. Knowing how the market may react to certain events or news updates makes it possible to plan a trading strategy to capitalize upon these potential movements.
The relevance and impact of individual news items on markets vary. Reaction to major economic news can result in significant market movements, whereas the effect of less important information will have more subtle influences on price movements.
A massive amount of information released daily can be used to plan and manage trades effectively.
Below is a list of the types of data to watch for:
- Employment Rates
- Interest Rate Movements
- Retail Sales Figures
- Trade Balance Reports
- Gross Domestic Product Information
- Inflation Reports
- Durable Goods Reports
There are many resources available, both in traditional media format and online, that will have detailed information relating to the scheduling of these news reports. Many online websites and forums will also allow you to activate specific updates to inform you of all relevant releases relating to a currency of choice.
Make sure that you know which news releases are due each week. It can be helpful to create a diary of events that you feel may have significant influence and then utilize this information in the planning of future transactions.
Trading Using Fundamental Forex Market Analysis
There are some essential points to learn when using fundamental Forex Market analysis.
The effect of the news on currencies is generally related to the difference between the expected results (which will already be priced into the market) and the actual results. If a news report meets expectations, there will likely be little movement in the corresponding currency. However, where results differ significantly from those expected, there will likely be a substantial price movement as the market adjusts accordingly.
When hotly anticipated news stories are due for release, there is often a quiet period in the markets before updates. If the released information is unexpected and produces subsequent currency price movements, price changes are often rapid and short-lived. Therefore, it is essential to be ready to react quickly in response to information updates when trading fundamentals.
Some economic information has a more significant impact on the market than others. News releases that can have a substantial effect on market activity include:
- Interest Rates (Currencies tend to rise accordingly) where interest rates are up.
- Employment Figures (Higher employment rates mean more people in work, generally reflecting a more robust economy and an equally strengthening currency).
- Gross Domestic Product (Higher GDP suggests economic resilience and a strong currency).
Less important news releases include:
- Retail Sales (Still a good indication of economic performance).
- Durable Goods Orders (Provides a measure of manufacturing performance)
Some factors associated with the trading of fundamental information require a degree of caution. One example is that market volatility often increases considerably during periods directly following news releases. This can lead to prices changing fairly rapidly over brief periods. Erratic price fluctuations can also accompany this rapid movement. Depending on the execution rates of individual brokers, these fluctuations can result in trade orders being fulfilled at prices that are different from what you expected, as the price may change during the time taken to implement a transaction. This situation is known as price slippage.
This volatility can also cause prices to swing between gains and losses over short periods. You should closely monitor the market at these times and be aware of how this movement is affecting your trades.
It is vital to understand the impact of fundamentals on the market thoroughly. If you are new to trading, then it is essential to learn the impact of news releases before trading at these times, as markets can suddenly and rapidly swing in opposite directions, wiping out your profits. Many websites and information sources provide Forex news schedules and should indicate the relative importance of each. Using a mixture of these resources makes it possible to gain a reliable indication of the likely impact each scheduled item may have on the market.
Fundamental Forex Market Analysis – Interest Rates
Interest rates are one of the most influential factors relating to the value of a currency. Understanding how central banks use interest rates to try and control economic activity helps a trader determine how currencies are perceived to be performing. Central bank decisions relating to interest rates are possibly the most important fundamental news items and should always be closely monitored.
Central banks' principal reason for interest rate adjustments is to control inflation, limiting the rise in the cost of goods and services within a region. Rapid inflation means that prices on everyday goods and services, commodities, etc., are increasing too fast, eroding commerce’s spending power and the public. While a degree of inflation is an accepted element necessary for a growing economy, it can be harmful to economic activity when inflation increases too rapidly. Therefore, central banks will attempt to maintain stable low-level inflationary conditions using interest rates.
In simple terms, this is achieved because central banks will often raise interest rates when there are high inflation levels. This results in businesses and individuals saving more and spending less, thus resulting in reduced levels of economic activity and helping to reduce inflation. Alternatively, when interest rates are lowered, this tends to encourage people and businesses to borrow more and save less, increasing economic activity.
Trading Strategy: In Forex trading, the higher the interest rate acting upon a particular currency, the better the chances of that currency strengthening over time. Currencies with lower interest rates are likely to have weaker currencies.
Fundamental Analysis – Interest Rate Differentials
It is possible to use the difference between the interest rates acting upon two currencies to determine whether one currency may be strengthening or weakening against another.
Key Lesson: An interest rate differential that increases supports the higher-yielding currency, whereas a decrease differential helps the lower-yielding currency.
Fundamental Analysis – Example
An excellent example of how fundamental elements can influence the movement of currency prices is to consider the importance of critical central bank decisions. When a country’s central bank makes vital decisions relating to its economy, there will always be a subsequent effect upon its currency and any connected currency instruments.
Suppose the European Central Bank wishes to try and improve conditions to encourage export. They may decide to sell euro holdings and resort to purchasing a non-euro-zone currency like the US dollar. The intended result from a move such as this would be a subsequent drop in the euro’s value against the dollar, making it cheaper for businesses within the euro-zone to export goods and services. Often the announcement of critical figures relating to moves, such as these, cause traders to begin to pre-empt movement in prices, driving prices lower, meaning the market itself helps move the currency value lower.
As a Forex trader, it is essential to be aware of announcements such as this example, understand how the market may react in the short term, i.e., to the information itself, and then be mindful of the longer-term implications for the economy. By understanding how currencies can move, immediately and in the future, about fundamental economic strategy, you will be able to identify related trading potential.
Technical Forex Market Analysis
Unlike fundamental Forex Market analysis, which uses economic data and news information to try and predict future possible price movements, the technical analysis relies upon studying the actual movements in market prices to identify discernable trends and patterns from the data.
The idea is that historical price patterns should indicate future market fluctuations.
Essential to technical analysis is observing and examining charts plotting past price movements. These provide the basis for determining possible future movements, trends, and fluctuations in the price of currencies and vital information for planning and executing a trading strategy.
Many methods are available to a Forex trader using technology to analyze the foreign exchange markets. One element essential to all of these, which will form the starting point for each process, is the ability to chart and understand price movements. By observing historical price data, the aim is to try and understand the levels that future prices may achieve. Charts can also be handy for highlighting long and short-term trends and revealing patterns in the information that can be used to help examine market conditions.
In addition to the basic presentation of price, information charts also provide many opportunities to apply mathematical and statistical analysis, further uncovering important trends and patterns. Identifying these chart patterns is key to technical studies, as they illustrate the past, current, and potential future movements in price and underlying market conditions. Using these as a trader makes it possible to plan where and when trading transactions should be executed and define the strategy behind each trade.
Technical analysis is fluid, meaning that as conditions change in the marketplace (which can happen rapidly or over more extended periods), the analysis helps to break down this information and present a more unambiguous indication of what is happening and ultimately what may occur as a result. To a trader, this type of information is vital, as it helps to convert seemingly random fluctuations in currency price movement into discernable representations of underlying trends and patterns.
There are many different types of technical analysis ranging from techniques that require the identification of specific patterns within the price data to others that rely upon mathematical manipulation of the data to produce tools that indicate when and how trading should be potentially undertaken.
Effective technical trading should use these analysis techniques, as this helps to reduce the risks of identifying false trends or indications. Multiple analysis techniques applied to the same data at any one time will help reduce the risk of losses and increase the likelihood of accurately identifying actual trends and patterns.
At first glance, this can all seem complicated. There are varying degrees of skill required to learn each technique and apply it to everyday trading activities. However, technical analysis will become an instrumental and essential part of your daily trading activity once mastered and understood. Developing a firm understanding of the basics will allow you to build highly effective trading strategies that will become increasingly more accurate as each new skill adds a degree of complexity that can be applied.
Understanding the meaning and implications of past price movements is essential for any trading activity. Technical analysis provides the simple tools necessary to help structure and manage the when, where, and why of every trading transaction you make.
Fundamental Analysis vs. Technical Analysis
Both fundamental analysis and technical analysis methods are handy tools when trading Forex. However, while some people develop trading strategies based solely upon only one or the other of these methods, this is rare. In most cases, the two types of analysis should not be mutually exclusive.
To become a successful trader, it is essential to understand and use both methods to provide supporting trade signals.
In practice, this may mean using technical analysis first to discover the underlying trends in a currency price and identify patterns and indications of where and when to enter the market. This analysis should then be supported by finding news sources or market reports using fundamental analysis that provides further evidence to reinforce or negate the trading strategy. News items relating to the economy’s strength for that particular currency should confirm or deny the initial analysis and may also identify key news events from the trading calendar, which could significantly influence the price movement.
Using the two types of analysis, the chances of something occurring by surprise and ruining an otherwise credible trading strategy are significantly reduced.
While technical and fundamental Forex market analyses tend to rely primarily on raw data to determine potential price movements, a successful trader should also learn to consider the third type of analysis, which involves judging overall market sentiment. This is the process whereby a trader will attempt to determine the thoughts and feelings of other traders and try to develop a strategy based upon this group psychology. Whether market traders are bullish or bearish is critical when planning trades. Market sentiment is a difficult concept to measure and comprehend. However, the experience will gradually produce the knowledge required to gauge this sentiment correctly.
Bulls and Bears
The term bull market, or when traders are said to be bullish, refers to times when there is considerable optimism in the marketplace, giving rise to larger numbers of buyers than sellers. These circumstances will often be accompanied by solid price rises and significant upward market movement. By comparison, if the opposite of this is true and there is considerable pessimism amongst market participants, this is known as a bear market, or traders are said to be bearish. Fewer sellers will generally accompany these conditions than buyers in the marketplace resulting in falling prices.