Types of Forex Analysis

Forex or foreign currency exchange is the buying and selling of currencies on the foreign exchange market with the intention of making money off the trade.

Forex Analysis

The foreign exchange market or Forex market determines foreign exchange rates for almost every currency in the world. It has been alluded to as the market closest to the ideal of perfect competition due to its unique characteristics, viz. huge trading volume, high liquidity, broad geographical dispersion, truly decentralized or over-the-counter (OTC) nature of transactions, continuous 24×7 operation except for weekends, use of leverage to enhance profit and loss margins.

The Forex market supports international trade and investments by facilitating currency conversion.  For example, it permits a company in India to import goods from any foreign country, say the United States, and pay US dollars, even though its income is in Indian Rupees.

International and domestic banks, business enterprises, investment management firms, money transfer/remittance companies, foreign exchange brokers and retail foreign exchange traders make up the bulk of the foreign exchange market participants.

Currencies are always traded in pairs, therefore, the forex market does not set a currency’s absolute value but rather determines its relative value by setting the market price of one currency with another for example, EUR/USD 1.2500 (or EURUSD 1.2500), meaning 1 Euro can be exchanged for 1.2500 US dollars. Here, EUR is the base currency and USD is the quote currency (counter currency). In a currency pair, one currency is purchased and the other is sold. In this case, Euros are being bought and US dollars are being sold.

Traders typically use Forex analysis to ascertain which currency within a pair is likely to be stronger. Naturally, they will buy the stronger currency and sell the weaker one. Thus, Forex analysis essentially is the process of determining whether to buy, sell, or hold a currency pair, manually or using a computer.

There is a wide assortment of analysis tools available on Forex trading platforms, of which the major and widely employed types of market analysis are:

  1. Technical Analysis
  2. Fundamental Analysis
  3. Sentiment Analysis

1. Technical Analysis

Technical analysis mainly focuses on identifiable price trends and conditions. The core principle of technical analysis is that a market’s price reflects all relevant information impacting that market. Furthermore, it is believed that price action tends to repeat itself due to the collective, patterned behaviour of investors.

Technical analysts endeavour to forecast the direction of prices of currencies by examining past market data, primarily price and volume trends. Colloquially known as charters, they attempt to search for repeated price chart patterns such as head and shoulders, double top/bottom etc. to predict the movement of the market. One such popular technical analysis tool is the candlestick, which provides comprehensive information of the trade at a glance.

A candlestick chart displays the high, low, open and closing (HLOC) prices for each period designated for the candle. The body of each candlestick represents the opening and closing prices while the candle wicks display the high and low prices for each period. Green or bullish candles indicate that the price closed higher than where it opened, while a red or bearish candle means the price closed lower than where it opened.

Also Read: 15 Weakest Currencies in the World

Technical analysts mainly utilize automated computer programmes for charting, analysis and reporting functions, which enable processing of enormous amounts of data in a relatively short time.

2. Fundamental Analysis

Fundamental analysis examines the influence of various macroeconomic and geopolitical factors on the movement of exchange rates viz. GDP, employment level, inflation and interest rate, balance of payment, fiscal and monetary policy, political stability, retail sale, economic productivity, so on and so forth.

Suppose a popular tourist destination country with a strong currency is riddled with internal strife such as a political coup and ensuing civil unrest. Obviously, tourism will be adversely affected with less and less people wanting to visit that country. Consequently, demand for this country’s currency will also be reduced, eventually driving down the price of the currency in the Forex market.

As you already know, the exchange rate of a currency is governed by demand and supply forces. Favorable macroeconomic conditions tend to drive up demand for a country’s currency and vice versa. Fundamental analysts primarily believe that if a nation’s current or future economic outlook is good, its currency should strengthen. This belief stems from the fact that a healthy economy attracts more investment from foreign companies and investors, which ultimately translates into increased demand for purchasing that country’s currency to acquire assets in the country.

Fundamental analysts generally scrutinize daily news reports and reputed economic and statistical publications to predict the movement of currency pairs.

3. Sentiment Analysis

Market sentiment indicates how investors feel about a particular currency. It is also referred to as crowd psychology. It is based on how many people are buying or selling a particular currency depending on their thoughts about which direction a currency will go.

But how does the market sentiment affect the price of a currency? Let’s assume that the market sentiment is that the price of a currency is going to improve and a large number of investors purchase this currency. Once the currency reaches its expected peak price, these investors will look to book their profits by selling the currency. But as the investors start selling the currency, the price of the currency would automatically start going down. This would eventually result in loss to a lot of the investors. Thus, even though the market sentiment was that the price of the currency would increase, the subsequent herd mentality ultimately led to a price reversion. Identifying such distinctive situations is the crux of sentiment analysis.

Traders use sentiment analysis to describe a market as bullish or bearish, with a bear market characterized by prices going down, and a bull market by prices going up. Traders judge market sentiment by using a range of tools or sentiment indicators or by simply watching the movement of the markets, using the resulting information to make their decisions. Sentiment analysis is based on instinct and as with other intuitive analytical methods; it develops gradually with practice and is refined with experience.

Summing-Up

So, which type of Forex analysis is the best for you? The answer is – ALL THREE!

While technical analysis can effectively predict future price trends based on past analysis, an impending geopolitical reform or crises may skew the trend lines in a completely different direction. Similarly, a strong intuition of market sentiment can safeguard against potential losses or result in propitious gains for the trader. Thus, all three strategies are most effective when employed in tandem.

The Forex market is constantly evolving. What worked for you today may not work for you tomorrow. In order to become a successful Forex trader, it is vital to know how to efficiently use Forex analysis methods and to keep abreast of the latest developments in the Forex markets.

See also: Currency Converter Tool Online

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