Traders and investors use forex analysis to find the best trading opportunities for different currency pairs and determine whether to buy, sell, or wait on trading a currency pair.
Types of Forex Analysis Techniques
Some traders focus their analysis on predicting how the market is likely to react to the economic and political news coming out of countries, we call this fundamental analysis. Others study price action on charts to make their trading decisions, we call this technical analysis.
Fundamental Analysis.
This forex analysis technique aims to study related financial and economic factors to measure the intrinsic value of a currency in the market.As a country’s economic health is a primary factor in the exchange rate of its currency, a fundamental analyst will study macroeconomic factors affecting a country’s economy. These often include the political climate, national GDP and unemployment rates and liquidity factors such as inflation and interest rates.Because some nations are driven by particular industries, for example, the economy of the UAE has traditionally been driven by the petroleum and petrochemical industries, some advanced fundamental analysts will also study the microeconomic factors of key companies within those industries, such as the effectiveness of the company’s management, revenues and supply chain factors.If the market has undervalued the currency, the trader buys it, aiming to sell it later at a higher price when the market catches up with its intrinsic value.On the other hand, the trader will sell the currency if the market has overvalued it and buy it back later when the market value has decreased in line with the trader’s assessment.Either way, the investor makes a profit.
The Key Pillars of Fundamental Analysis
The concept of the intrinsic value
Intrinsic value is the actual value of a financial asset, and fundamental analysis has its roots on the presumption that the current price of the asset does not fully reflect its actual value. The asset is either overvalued or undervalued by the market.
Ultimately, the market catches up with the fundamentals
The assumption is that the market catches up with the fundamentals in the long run and reflects the intrinsic value of the asset. So, undervalued assets can be bought now at a low price and sold later at a higher price, while overvalued assets can be sold now at a high price and bought later at a low price.
Fundamental Analysis Tools
Fundamental analysis relies on both quantitative and qualitative tools. A quantitative tool is anything that can be measured or expressed in numeric terms. They include:
•Economic data such as interest rates and unemployment rates
•Financial statements i.e. cash-flow statements, income statements or balance sheets Qualitative tools relate to quality or character, as opposed to size or quantity.They cannot be expressed in numeric terms. They include:
•The political climate and government policies
•Corporate governance
•Business model
•Company management
•Competitive advantage.
Technical Analysis
Technical analysis is the most widely used forex analysis approach by traders and it entails the use of various charting tools to generate short-term trading signals. It is a technique that is applicable to any financial asset with historical trading data. Analysts study the historical trading data of an asset such as price movements and trade volume to assess how supply and demand affect changes in the asset’s price, trade volume and volatility. These changes are referred to as “price action”.Technical analysis can be used to study price action in different financial assets, but it is most prevalent in forex and commodities markets where traders seek to profit from short-term price movements.
The Key Pillars of Technical Analysis
There are three important assumptions that form the basis of technical analysis.
History repeats itself
The assumption is that past price action and patterns reflect the market psychology based on investor sentiment. Since these investor's emotions are predictable under the same market conditions, past chart patterns can be studied to understand current and future market price movements and trends.
Price moves in trends
Most trading strategies assume that, regardless of the timeframe being observed, technical analysts expect prices to exhibit trends. The goal of the trader should be to identify either an uptrend, a downtrend, or a ranging trend in the market.
The market reflects everything
This technique presumes that all factors from economic factors to market psychology are already priced into the current market price of the asset. With all those factors already priced in, the only thing an investor needs to do is study price movements which technical analysts believe to be subject to the law of demand and supply of the security in the market.Technical analysis boils down to the use of charting tools to identify a bullish, bearish, or ranging trend in the market, and use of different types of tools and indicators to spot ideal entry or exit points.
Technical Analysis Tools
•Charting tools are used to generate buy or sell signals e.g. candlesticks.
•Technical indicators indicate trends or patterns in the market.They come in two basic types:
1.Overlays like Fibonacci lines, moving averages, and Bollinger bands.
2.Oscillators like Relative Strength Index (RSI) or Moving Average Convergence Divergence (MACD).
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when trading in CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
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