Accurate analysis of the Forex currency market is the main competence of the trader's profession. Daily Forex market analysis opens wide opportunities for trading participants to make balanced, adequate, and correct decisions - both at the opening and at the closing of positions, allowing to optimally increase profits and minimize risks. It is possible to analyze the economic situation with the help of many trader's tools, which constitute three main methods of Forex market forecast and analysis. Namely, there are fundamental, sentiment, and technical analysis of the Forex market. Ideally, they are used by a trader simultaneously when making trading decisions. So, in this article, we will go through all these types of analysis of the Forex market.
This type of analysis is closer to pure mathematics or engineering task. Its purpose is to collect information about the patterns of course movement and extrapolate them into the future, to formulate the rules of chart movement, understandable even to a computer algorithm. It is a technical analysis that is used in automated trading, where the speed of reaction to the chart movements and coolness are important.
A trader who uses this type of analysis actively uses the history of trading in his work. Market trends may not be visible at first glance in daily trading, and chart movements may look chaotic and unpredictable. But if you only expand the time frame, trends appear as a pattern on the surface, and conclusions from them are subject to mathematical laws.
The technical analysis is based on two methods: mathematical and graphical. The mathematical method allowed us to create a lot of indicators of the Forex technical analysis to help a trader. Using them in your work, you react to the signals that this or that indicator gives you. The choice of the indicator will depend on the currency pair. The graphical method is presented in the figures of technical analysis in the Forex market, which also signals to the trader whether to buy or sell. As a rule, various technical analysis tools are installed directly in the trading terminal and used there, which is very convenient.
Technical analysis usually comes down to identifying the most appropriate moment to enter the market - it can be to find the point of a trend reversal, to determine whether the direction of the current market is suitable for entry, or, for example, to identify potential opportunities for earning even during the flat period. On an uptrend or a bullish trend, you can earn on the rise of the price of a currency pair, as well as on temporary pullbacks (corrections).
In case of an unexpected price reversal, the trader will have to determine on his own at least the approximate time of closing trades. The search for the closing point is carried out the same way.
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A demo account is a perfect opportunity to get acquainted with the trading platform for those new to trading. You can study charts, make market observations, analyze stocks.
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As per Charles Dow, the founder of technical analysis, price includes all the necessary information, whether it is economic news or political. In price movements, everything that happens to the currency market is encrypted. For this reason, adherents of Price Action study the very essence of the price movement, instead of reading miles of news announcements and analysis.
First of all, it should be noted that this method is effective in long-term trading, where the main time frame is D1. The advantage of such a chart is that it eliminates unnecessary market noise in the form of chaotic price fluctuations. Another advantage of long-term trading - a trader spends less time on market analysis, sometimes 15 minutes of work with the chart during the day is enough.
The working signals in the system are the so-called candlestick patterns - periodically repeating patterns called set-ups or Price Action patterns.
Despite the fact that all you need for Price Action analysis is just a candlestick chart, the system works very well and provides fairly accurate signals.
The main problem in trading Price Action is the correct identification of candlestick patterns.
To recognize the pattern is not as easy as it may seem at first glance, and to learn to do it correctly, you need to practice a lot.
There is a whole lot of candlestick patterns in the system, but you can start practicing only with the most common ones, like DBLHC, DBHLC, TBH, CPR, and others
The charts for technical analysis of the Forex market are drawn in coordinates: price (vertical axis) - time (horizontal axis). In Forex, the following types of currency prices are distinguished and reflected in the charts:
Open prices - prices at the beginning of a trading day or the beginning of any trading period (month, week, hour, minute, etc.);
close prices - prices at the end of a trading period;
highest (high) - the highest prices observed during the trading period;
the lowest - the lowest prices observed during the trading period.
In technical analysis, charts are built and considered in different time frames - from 1 minute to 1 month. The higher the time frame is used for drawing the chart, the longer is the time interval for analyzing price movements and identifying the main trend.
With the mass emergence of computers, indicators began to play an important role in technical analysis. At the moment there are so many of them that it is impossible to list. There are trend indicators, oscillators, volume-based indicators, etc. But nobody has invented the ideal one yet and will never invent it.
Each indicator (oscillator) is built on only five values, which are available to every trader for viewing:
It is believed that oscillators are built in a separate window and their main task is to show the "overheated" market. They are not designed to determine trends in contrast to indicators.
The main idea of trading strategies based on indicators is based on their readings. There are concepts of "overbought" and "oversold". If some oscillator has entered this zone, analysts will advise opening positions in the opposite direction.
The method of fundamental analysis of the Forex market is based on assessing the political and economic situation that affects currency rates. As you know, the system of finance is very thin and is saturated with a lot of barely noticeable interconnections. Fundamental analysis is designed to find such relationships and make predictions about changes in the exchange rate of a country based on them.
Players who place orders based on the quality of the company's fundamentals usually trade long- term and do not pay attention to the gymnastic tricks that the market performs on a particular day or week.
Within the framework of fundamental analysis, a trader uses a lot of tools, including regularly published macroeconomic indicators of the world economies, the state of politics, the expectations and rumors of ordinary people, statements of persons significant in the world economy, emergencies, natural phenomena and terrorist acts, news and much more. To facilitate traders' work, brokers offer an economic calendar. With its help, you can stay informed about the most important economic news and react to them accordingly. However, one calendar is not enough. The general development of a trader, his knowledge and ability to identify regularities are also important here. This type of Forex market analysis today is the most complex - and, consequently, often it is neglected by traders.
As in any case, this type of analysis has both its pros and cons. The disadvantage of this analysis, for example, is its complexity and the amount of time it will take to perform it.
The majority of traders have mastered and apply this method rather superficially, while the global application of fundamental analysis is typical for high-class analysts. But even if a trader has mastered this method more deeply, he will have to make decisions independently, even if some factors are contradictory.
It should be taken into account that even the presence of basic knowledge of fundamental analysis of the Forex market will benefit the trader.
Economic Theories and Raw Data
Apart from the fundamental factors, there are economic theories connected to such notions as parity and arbitrage. As a rule, they have little influence on a trader's daily activities, but it is still necessary to have at least a general idea of these theories. Some of them are:
Purchase Power Parity (PPP) is the ratio of currencies, taking into account price levels in different economies based on equality of estimates in national prices and currencies for a comparable set of goods and services.
Interest Rate Parity (IRP) - this theory is based on the relationship between the interest rates of two currencies and their exchange rates and the main condition for achieving IRP is that regardless of the level of interest rates, the total income from equal investments in different countries should be the same.
Balance Payment Theory (BPT) - asserts that changes in the exchange rate depend on the trade balance- if there is a large deficit or surplus in a country's current account, it indicates an unbalanced exchange rate. If there is a large trade deficit (the country imports more goods than exports), the national currency will depreciate, and vice versa.
Real Interest Rate Definition Model (RIRDM) - assumes that the exchange rate of the national currency in countries with high-interest rates will increase relative to the currencies of countries with low-interest rates. This is because investors around the world will transfer money to higher-income countries and demand for those countries' currencies will increase.
Asset Market Model (AMM) - accounts for cash inflows from foreign investors buying shares, bonds, and other financial instruments. If the inflow of capital from foreign investors is large, the national currency starts to grow, so the demand for it from these investors increases.
One more important aspect of Daily Forex market analysis today any trader should be reckoned with raw data released almost every day by governmental authorities, e.g. Non-Farm Payrolls, Monetary Policy meetings, Retail Sales, GDP, interest rate decisions, and so on. If you want to keep up with the newest updates and to take advantage of all the short-term reactions after the release, make sure to use the Economic Calendar.
Sentiment Analysis in the Forex market is to determine which positions for a particular currency pair are open - mostly short or long. Forex traders use this important tool to gain insight into the open positions of market participants and therefore make decisions based on what may be required from them in the future.
Market sentiment analysis is a promising tool often used by traders moving against the market crowd to open long or short positions. The principle of their strategy is that if mainly long positions are opened for a particular currency pair, the only direction in which the price will move forward is downwards. Since these long positions will necessarily be closed by selling.
While understanding the main existing types of Forex market analysis today is important, sentiment analysis, which is an addition to the trader's arsenal, is often underestimated. By applying this analysis to your trading, you can gain an advantage over those who use only technical or fundamental analysis.
Market sentiment changes rapidly, usually after one or more unexpected economic reports. However, the change in sentiment does not automatically mean that the fundamentals have changed and this, in particular, provides an excellent trading opportunity to enter a trade at a better price.
Often a sentimental movement will only be a recovery of a larger fundamentally-oriented trend, and it is only a matter of time before the fundamentals change, and the sentiment changes in the same direction as the fundamentals. In this case, very sharp changes in prices happen very quickly.
Each type of analysis has the same meaning, and none of them can be highlighted. Many traders and investors prefer to use a single analysis method to evaluate long-term investments or to generate short-term profits. The combination of fundamental, technical, and sentimental analysis is the most advantageous. Each analysis method requires the support of another one to provide us with enough Forex market data.
These three strategies go hand in hand to help you find good trading ideas in the Forex market. There is all the historical price action (for technical analysis) and economic indicators (for fundamental analysis) - all you need to do is limit your thinking (for sentimental analysis) and test these analytical skills.
To become a professional Forex trader, you need to know how to effectively use these three types of Forex analysis methods.