When it comes to trading Forex, many are at a loss on how to analyze the market and predict price movements. This guide will break down what fundamental and technical analysis is, and how traders can use them to their advantage.
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What is fundamental analysis?
Fundamental analysis is the study of price movements in the Forex market based on the real world. It is an essential part of the trading analysis because currency prices are partially driven by expectations. The primary driver of currency prices is the economic health of the currency’s issuing country.
Below, we will explore some key factors that fundamental analysts investigate when we talk about the wider economy and a country’s economic health.
Gross Domestic Product (GDP)
GDP is the measure of a country’s output of products and services. It is an excellent indicator of the economic performance of a country. GDP does not consider whether business owners live abroad or locally if a company’s performance is located within its regions. Therefore, foreign companies building factories or opening branches in a host country is seen as good news for the host country.
When a country’s GDP is positive, the economy is growing. When it is negative, the economy is shrinking. As a Forex trader, you should look for a 1 to 5% consistent annual growth. This indicates a healthy rate of growth for mature economies. In these cases, a country’s currency is likely to be strong.
One of the most important things to consider is inflation.
Inflation is the measure of price changes within the economy. In other words, it signifies the purchasing power of currencies. For example, if a country has an inflation rate of 10% per annum, it means that this time next year, your Euro will be able to buy you 10% less than what you can buy today. In other words, to buy the same amount of goods in one year, you will need 1.10 EUR.
Historically, a healthy figure for inflation is 0.5 to 4% per annum. A steady inflation rate can indicate a healthy and stable economy for a country.
Another important factor Forex traders can look at is a country’s interest rates. They are set by the central bank or government in each economy. This is the borrowing rate of the central bank. Interest rates are used to keep inflation low, and higher interest rates mean it becomes more difficult to borrow money.
In times of high or increasing interest rates, people have less money to buy goods and services. This leads to a reduced demand for these goods and services, which in turn reduces prices and inflation. As a Forex trader, you should look for low and declining interest rates of a country.
Other fundamental factors
Beyond the economic health of a country, traders also look at news events that take place globally. These include FOMC meetings, where interest rates and determined. They also include the release of unemployment, GDP, and inflation figures. They can all offer ideas on how a currency may move.
A country in conflict will see plummeting currency rates, as will a country that experiences a death of a highly ranked official or party leader. Political influences will also have an impact on a currency’s strength.
For example, when the UK announced its Brexit decision in 2016, the Pound plummeted to new lows that year. In the following years, as the Brexit plan is enacted, the Pound continues to dip up and down. When the UK finally left the EU, the Pound recorded new lows due to the instability that came with this new chapter.
What is technical analysis?
Technical analysis is the study of price movements in the market to make predictions. It is when a trader finds and recognises trends and patterns in price charts and analyses them to make investment decisions.
The two major forms of technical analysis comes in the analysis of price patterns and the use of indicators.
Price patterns are simply the patterns on a price chart. They are often analysed within a specific timescale, such as 4 hours or 1 hour. They can be seen as simple line graphs, bar graphs, and Japanese candlesticks. Technical analysts also look at the opening, closing, high, and low prices of a day.
One of the simplest price patterns is support and resistance. Support is where the price finds a base from which it bounces upward, and resistance is where the price finds a ceiling from which it bounces downward.
Technical analysts find clear lines of support and resistance on charts, so they understand the previous highs and lows of a currency pair. This helps them determine trends in price charts that can help with predictions.
Aside from finding patterns in price charts, technical analysts also use indicators. They are tools that provide insight into price movements. Some popular tools include Moving Averages, the Relative Strength Indicator (RSI), and the Stochastic Oscillator.
Traders do not need to use all of them to make good decisions. More likely than not, they will be able to master one or two tools and use them to inform future strategies.
The Moving Average Convergence Divergence (MACD) helps traders spot trend directions. It also provides insight into the momentum of the trend. When the MACD is above zero, there is a positive trend. If it is below zero, there is a negative trend.
The Relative Strength Index (RSI) is an indicator that moves between 0 and 100. Traders use it to plot price gains against price losses. This is also a tool used to gauge trends and their momentum. RSI uses overbought and oversold indicators. When it is below 30, it means an asset is oversold. When it is above 70, it means an asset is overbought.
Finally, the Stochastic Oscillator measures the current price of an asset relative to the price range over several periods. It also moves between 0 and 100. When the indicator is above 80, the asset is considered overbought. When it is below 20, the asset is considered oversold.
An important thing to remember about technical analysis is that it is not an exact science. Price movements in markets are, after all, unpredictable. This means that there is always a chance for your predictions to come true or be wrong. Therefore, traders should open positions with reasonable expectations.
What type of analysis should I use?
You may be wondering where you should start, and which method you should choose.
The truth is that the strongest Forex traders combine both fundamental and technical analysis to inform their investment decisions. They make sure they have a comprehensive view of the markets and the economy. This helps them lower their risk levels significantly. Therefore, you should always consider both methods of analysis before you trade Forex.
The bottom line
The most important thing you should know as a Forex trader is how to read and analyse the markets. Once you have a solid grasp of what moves currencies, you can trade with confidence. There is a wealth of online resources, including guidebooks, seminars, and websites for you to hone your skills in fundamental and technical analysis. The more you learn, the easier Forex trading becomes.