Forex Analysis in Forex Trading Explained for Dummies

 

Analysis – an introduction

There are numerous definitions of the word ‘analysis’ and a wide variety of analysis types. Therefore, the following definition of ‘analysis’ is only one of many, but for the purpose of this article, sufficient: An analysis is a detailed study, examination, and evaluation of something, by dividing it into its different elements in order to discover how they relate to one another and to understand more about it.  

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Types of forex trading analysis

There are four basic types of forex market analysis, namely fundamental analysis, technical analysis, weekend analysis, and sentiment analysis, of which fundamental analysis and technical analysis are the most prominent ones. The focus of this article will mainly be on these two types, with short references to the other two.  

1. Weekend Analysis

Weekend analysis refers to a strategy where a trader makes use of the closed markets over the weekend to establish a better understanding of the particular market in which he or she is trading. Commonly speaking, to get a ‘big picture’ view of the market, by studying some of the dynamics of the market and the performances of specific currencies. Furthermore, weekend analysis enables traders to plan and prepare for the coming week’s trading challenges in order to ensure profitable transactions.  

2. Sentiment Analysis

Sentiment analysis in forex trading is to determine how other traders feel about a specific currency pair in order to decide on your own trading decisions in the forex market.  

3. Fundamental Analysis (FA)

In forex trading, fundamental analysis is the study and evaluation of macroeconomics data and the application of the conclusions thereof in the forex market. This is done in order to provide forecasts on future trends in the market, identifying possible turning points or changes in the direction of currency prices. Generally, a prominent feature of this type of analysis is to determine the intrinsic value (true value) of a financial instrument or an asset. Applied to forex, FA implies examining the economic conditions that affect the value of a country’s currency. The reasoning behind fundamental analysis in forex trading is that if a country’s current or future economic picture is strong, its currency should strengthen and vice versa. The healthier a country’s economy, the more businesses and investors from other countries will invest in that country. This results in a greater demand for that country’s currency. Some of the fundamental factors that have an influence on the value of a country’s currency are:

• Balance of trade, also known as trade balance

The balance of trade is the difference between a country’s imports and exports over a given period of time. A positive trade balance is when exports exceed imports, indicating a trade surplus. A negative trade balance is when imports are more than exports, signifying a trade deficit. In the case of a trade deficit, a country sells a lot of its currency to pay for imports, resulting in the devaluation of the currency.  Contrarily, the consequence of a trade surplus is an appreciation of a country’s currency against other currencies.

• Inflation rates

Inflation indicates the rate at which the general level of the prices for goods and services is rising in a country. Higher inflation rates depreciate a country’s currency, with the result that it becomes a less reliable asset for foreign investors.

• Interest rates

Generally, higher interest rates increase the value of a country’s currency, provided that the levels of inflation are low. Therefore, when a country’s real interest rates (nominal interest minus inflation) are high, foreign investors are attracted to invest in the country, increasing the demand for and value of the local currency. Contrarily, foreign investors may find lower real interest rates unappealing, resulting in decreasing foreign investments and a depreciating currency.

• Expectations

Expectations are a driving force in the forex market. Exchange rates can greatly be impacted by expectations based on the following economic indicators of a country: the economic growth rate, the future inflation rate, unemployment numbers, monetary policy, and political announcements.  

4. Technical Analysis (TA)

Technical analysis is a method utilized in forex trading to examine and predict price movements of currencies, by using and analysing historical price charts and market statistics. It is assumed that if a trader is able to determine previous market patterns, they can fairly accurately predict future price trends. The following tools are some of the major ones available in technical analysis.

• Charts: the most common chart patterns are, among others:
• Line charts - show the price dynamics of financial instruments, such as currencies, in the course of time.
• Bar charts - present data with rectangular bars at heights proportional to the values they represent.
• Candlestick (candle) charts – display the open, high, low, and close (OHLC) price levels as ‘candlesticks’ with wicks, to indicate buyers and sellers sentiment over a short time period.
• Support and resistance levels: Resistance levels are above current market prices, and support levels below them. Support levels are often observed as a ‘floor’ which is supporting (holding up) declining prices, while resistance levels are viewed as a ‘ceiling’ which is preventing prices to continue in an upward trend.
• Indicators - there are numerous indicators available in technical analysis to enable traders to understand market conditions, indicating different aspects of price movements and providing signals when the market is overbought or oversold.

Indicators comprise the following two main groups:

• Moving averages - one of the most popular technical analysis tools to check price movements over a given timeframe. It is used to identify support and resistance levels, and to highlight the prevalence of a trend by smoothing out the impact of the extreme values over a given period of time.
• Stochastic oscillators - momentum indicators that determine whether a currency pair is overbought or oversold.
• Trends - the general direction in which a currency’s price moves within a period of time. There is an imbalance between supply and demand, with uptrends when buyers dominate, and downtrends when sellers carry the day.

 

In conclusion

There is no flawless or ultimate method of analysis for forex trading between technical and fundamental analysis. The most usable and workable option for traders depends on their time frame available and access to information. Both methods have the potential to enable traders to trade with more confidence and knowledge. And keep in mind, ‘Knowledge is power.’ (Thomas Jefferson, third president of the USA.)    

Frequently Asked Questions

  What is forex analysis? For a good explanation take a look at this guide - Forex Analysis in Forex Trading Explained for Dummies. What are the basics of forex analysis? Forex analysis comes down to 2 basics - identifying of a trend & identifying resistance/support by making use of timeframes and/or price charts. What are the types of forex analysis? You can read more about the type of forex analys here Is forex analysis important? Yes, absolutely.  Forex analysis can help you to determine not only when and where you should enter a market, but much more importantly, when and where you should get out. Can proper forex analysis totally unlock the secret of a very good forex trading strategy? Unfortunately forex analysis won't do that for you. You will need good management of risk,  discipline, and the ability to control your emotions    

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