Forex analysis is used by retail forex day traders to determine buy or sell decisions on currency pairs. It can be technical, using resources such as charting tools. It can also be fundamental, using economic indicators and news-based events.
Key Takeaways
- Forex market analysis falls into three categories: fundamental, technical, or weekend analysis.
- A fundamental analysis requires gathering your own information and interpreting it.
- A technical analysis relies on automated interpretation but it can involve your own input, too, as you effectively train the program to look for and collect certain information.
- A weekend analysis takes place when the markets are closed and sedentary so you can collect your data and make your decisions for the upcoming week.
Types of Forex Market Analysis
Analysis can seem like an ambiguous concept to a new forex trader but it falls into three basic types.
Fundamental Analysis
Fundamental analysis is often used to analyze changes in the forex market by monitoring figures such as interest rates, unemployment rates, gross domestic product (GDP), and other economic data that come out of countries.
A trader conducting a fundamental analysis of the EUR/USD currency pair would find information on the interest rates in the Eurozone more useful than those in the U.S. Those traders would also want to be on top of any significant news releases coming out of each Eurozone country to gauge the relation to the health of their economies.
Technical Analysis
Technicalanalysis comes in the form of both manual and automated systems. A trader analyzes technical indicators in a manual system and interprets that data into a buy or sell decision. The trader is "teaching" the software to look for certain signals and interpret them into executing buy or sell decisions in an automated trading system analysis.
Automated analysis can have an advantage over its manual counterpart because it's intended to take the behavioral economics out of trading decisions. Forex systems use past price movements to determine where a given currency may be headed.
Weekend Analysis
There are two basic reasons for doing a weekend analysis. The first is that you want to establish a "big picture" view of a particular market in which you're interested. The markets are closed and not in dynamic flux over the weekend so you don't have to react to situations as they're unfolding but you can survey the landscape.
The weekend analysis will also help you to set up your trading plans for the coming week and establish the necessary mindset. A weekend analysis is akin to an architect preparing a blueprint to construct a building to ensure a smoother execution.
Applying Forex Market Analysis
It's important to think critically about the tenets of forex market analysis. It can be helpful to follow a four-step outline.
1. Understand the Drivers
The art of successful trading is due in part to understanding the current relationships between markets and the reasons that these relationships exist. It's important to get a sense of causation and to remember that these relationships can and do change over time.
A stock market recovery might be explained by investors who are anticipating an economic recovery. These investors believe that companies will have improved earnings and greater valuations in the future as a result. This could mean that it's a good time to buy but speculation based on a flood of liquidity could be fueling momentum. It could be that good old greed is pushing prices higher until larger players are on board so the selling can begin.
The first questions to ask are: Why are these things happening? What are the drivers behind the market actions?
2. Chart the Indexes
It can be helpful for a trader to chart the important indexes for each market for a longer time frame. This exercise can help to determine relationships between markets and whether a movement in one market is inverse or in concert with the other.
Gold was being driven to record highs in 2009. Was this move in response to the perception that paper money was decreasing in value so rapidly that there was a need to return to the hard metal? Or was it the result of cheap dollars fueling a commodities boom? It could have been both or it could have been market movements driven by speculation.
3. Look for a Consensus in Other Markets
You can gain a perspective on whether the markets are reaching a turning point consensus by charting other instruments on the same weekly ormonthly basis. Take advantage of the consensus to then enter a trade in an instrument that will be affected by the turn.
Japanese exports could be affected if the USD/JPY currency pair indicates an oversold position and that the Bank of Japan (BOJ) could intervene to weaken the yen. But a Japanese recovery is likely to be impaired without any weakening of the yen.
4. Time the Trades
There's a much higher chance of a successful trade if you can find turning points on the longer timeframes and then switch down to a shorter time period to fine-tune an entry. The first trade can be at the exact Fibonacci level or double bottom as indicated on the longer-term chart. A second opportunity will often occur on a pullback or test of the support level if this fails.
Patience, discipline, and preparation will set you apart from traders who simply trade on the fly without any preparation or analysis of multiple forex indicators.
Acquiring Forex Trading Systems and Strategies
A day trader's currency trading system may be manually applied or the trader may make use of automated forex trading strategies that incorporate technical and fundamental analysis. These are available for free, for a fee, or they can be developed by more tech-savvy traders.
Both automated technical analysis and manual trading strategies are available for purchase on the Internet but there's no such thing as the "holy grail" of trading systems in terms of success. The seller wouldn't want to share it if their system was a fail-proof money maker. This is evidenced by how big financial firms keep their "black box" trading programs under lock and key.
What Is Behavioral Economics?
Behavioral economics describes a human tendency to make irrational rather than well-informed decisions even when the human has data available to make informed decisions. The dividing line is what an individual should do versus the actions they ultimately take. Behavior economics are based on the work and research of University of Chicago scholar and Nobel laureate Richard Thaler.
What Are Fibonacci Retracement Levels?
Fibonacci retracement anticipates areas of support and resistance based on horizontal lines. This identifies the point at which a stock or currency will reverse its current trend. The levels are shown as percentages. Minimum retracement hovers at below 40% in a strong trend but this can ratchet up to 60% or more in a weaker trend. The idea is to use the lines to try to anticipate what a market is going to do next.
What Is a "Black Box" Trading Program?
A black box trading system is programmed to create algorithms for other systems. The result is a computer system that can pinpoint potential buy and sell decisions in which you might be interested.
The Bottom Line
There's no "best" method of analysis between technical and fundamental analysis for forex trading. The most viable option for traders is dependent on their time frame and access to information.
Technical analysis may be the preferred method for a short-term trader with only delayed information on economic data but real-time access to quotes. Traders who have access to up-to-the-minute news reports and economic data may prefer fundamental analysis. It doesn't hurt to conduct a weekend analysis when the markets aren't in a constant state of fluctuation.
