Forex Traders use two types of Forex Analysis to predict future price movements in the Forex market and make their trading decisions. They are: Technical and Fundamental Forex Analysis.
What is Fundamental Forex Analysis?
Fundamental Forex analysis is basing the valuation of an asset on important economic reports. In forex trading, we refer to these reports as economic indicators. Comparing the employment reports from two countries and making a Forex trade based on that information would be an example of using fundamental Forex analysis.
What is an Economic Indicator?
An economic indicator is an important piece of financial data in relation to an asset. In forex trading, the assets are the currencies of different countries. For countries, some important economic indicators are: interest rate announcements, employment numbers, Consumer Price Index, and Trade Balance numbers. While some reports are constantly valuable in fundamental forex analysis, others will sometimes be either very important or less relevant. For instance, if a country is having solid growth and experiencing inflation, the Consumer Price Index will be highly watched and considered important by the Forex market.
Trading the News in Forex market
Forex Trading based on fundamental news can be a tricky matter. You can have a situation where the numbers come out very good for the asset that you want to buy, yet the asset will drop in value. This happens because the Forex traders in the forex market have certain expectations of what numbers will be in the report. They will speculate on the outcome before the economic report comes out and place their forex trades early on. If the report does not live up to their expectations, it won’t matter whether the news is good or not, the market can seemingly move in the wrong direction as the early forex traders dump their positions. In Forex Trading, to speculate on news is very risky and should only be done after several years of forex trading experience.
Fundamental forex analysis is an important part of learning to understand the forex markets. On the short run, the results are not always straight forward, they can even seem backwards. On the long run, currencies will always move along with fundamentals. Learning to use fundamental forex analysis will help you to understand the reasons behind trends and give you insight into currency movements.
What is Technical Forex Analysis?
The Technical Forex analysis is about what has actually happened in the forex market, rather than what should happen.
A Technical Forex Analyst will study the price and volume movements and from that data create charts (derived from the actions of the Forex market players) to use as his primary tool. The Technical Forex Analyst is not very concerned with any of the “bigger picture” factors affecting the forex market, as is the fundamental forex analyst, but concentrates on the activity of that instrument’s market. Technical Forex Analysis is based on three underlying principles:
Forex Market action discounts everything
This means that the actual Forex rates is a reflection of everything that is known to the Forex market that could affect it, for example, supply and demand, political factors and market sentiment. The pure Forex Technical forex analyst is only concerned with Forex rates movements, not with the reasons for any changes.
Forex Rates move in trends
Technical Forex analysis is used to identify patterns of forex market behavior which have long been recognised as significant. For many given patterns there is a high probability that they will produce the expected results. Also there are recognized patterns which repeat themselves on a consistent basis.
History repeats itself
Chart patterns have been recognized and categorised for over 100 years and the manner in which many patterns are repeated leads to the conclusion that human psychology changes little with time.
List of categories of the technical Forex Analysis theory:
Indicators (Oscillators, eg: Relative Strength Index RSI)
Number theory (Fibonacci numbers, Gann numbers)
Waves (Elliott wave theory)
Gaps (High-Low, Open-Closing)
Trends (Following Moving Average)
Chart formations (Triangles, Head & Shoulders, Channels)
Fundamental or Technical Forex Analysis?
When day trading, a Forex trader makes the decision about what to trade, when to trade, and how to trade, using either fundamental or technical Forex Analysis. Both forms of Forex Analysis involve looking at the available information and forex making a decision about the future price of the Forex market being traded, but the information that is used is completely different. Is it possible to use both fundamental and Technical Forex Analysis together, but it is more common for a Forex Trader to choose either one or the other.
Fundamental Forex Analysis
Fundamental Forex traders use information about the global and national economies, and the financial state of the companies involved, as well as non financial information such as current political and weather information. Fundamental Forex traders believe that the Forex markets will react to events in certain ways and that they can predict future Forex market prices based on these events.
For example, a Forex Trader for a given currency pair studies the supply and demand for the country's currency, products or services; its management quality and government policies; its historic and forecasted performance; its future plans and the most important for the shorter term, all the economic indicators.
From this data, the Forex Trader constructs a model to determine the current and forecasted value of a currency pare. The basic idea is that unmatched increases in supply tend to depress the currency value, while unmatched increases in demand tend to increase the currency value. Once the Forex Trader estimates natural value, he compares it to the current exchange rate and decides whether the currency ought to rise or fall.
Fundamental forex traders need access to all of the available information as soon as it is available, and are therefore often institutional forex traders with large support teams, rather than individuals. Fundamental Analysis has probably been in use since there were markets to trade, and has traditionally been done manually, but as computing power increases it has become possible for some fundamental information to be processed automatically.
Technical Forex Analysis
Technical Forex Traders use Forex trading information (such as previous prices and trading volume) along with mathematical indicators to make their Forex Trading decisions. This information is usually displayed on a graphical chart and is updated in real time throughout the trading day. Technical Forex traders believe that all of the information about a Forex market is already included in the price movement, so they do not need any other fundamental information (such as earnings reports). There are many different types of charts and many different mathematical indicators. Some indicators are better suited to short term Forex trading, and others are better suited for longer term trend following Forex trading. Individual Forex traders are usually technical Forex Traders. Technical Analysis appears to have been used at least 200 years ago in Japan. ModernTechnical Forex Analysis is usually performed by the Forex trader interpreting their charts, but can just as easily be automated because it is mathematical. Some Forex traders prefer automatic analysis because it removes the emotional component from their Forex trading, and allows them to take trades based purely on the Forex trading signals.