Two types of Analysis

Two Types of Forex Market Analysis

To begin, let’s look at two ways on how you would analyze and develop ideas to trade the market. There are two basic types of forex market analysis:

  1. Technical Analysis
  2. Fundamental Analysis

Technical Analysis

Technical analysis is the framework in which forex traders study price movement.

The theory is that a person can look at historical price movements and determine the current trading conditions and potential price movement.

The main evidence for using technical analysis is that, theoretically, all current market information is reflected in price. If price reflects all the information that is out there, then price action is all one would really need to make a trade.

Now, have you ever heard the old adage, “History tends to repeat itself“?

Well, that’s basically what technical analysis is all about! If a price level held as a key support or resistance in the past, traders will keep an eye out for it and base their trades around that historical price level.

Technical analysts look for similar patterns that have formed in the past, and will form trade ideas believing that price will act the same way that it did before.

 

In the world of currency trading, when someone says technical analysis, the first thing that comes to mind is a chart. Technical analysts use charts because they are the easiest way to visualize historical data!

You can look at past data to help you spot trends and patterns which could help you find some great trading opportunities.

What’s more is that with all the traders who rely on technical analysis out there, these price patterns and indicator signals tend to become self-fulfilling.

As more and more forex traders look for certain price levels and chart patterns, the more likely that these patterns will manifest themselves in the markets.

You should know though that technical analysis is VERY subjective.

Just because Ralph and Joseph are looking at the exact same currency chart setup or indicators doesn’t mean that they will come up with the same idea of where price may be headed.

The important thing is that you understand the concepts under technical analysis so you won’t get nosebleeds whenever somebody starts talking about Fibonacci, Bollinger bands, or pivot points.

 

Fundamental Analysis

Fundamental analysis is a way of looking at the forex market by analyzing economic, social, and political forces that may affect the supply and demand of an asset. If you think about it, this makes a whole lot of sense! Just like in your Economics 101 class, it is supply and demand that determines price, or in our case, the currency exchange rate.

Using supply and demand as an indicator of where price could be headed is easy. The hard part is analyzing all of the factors that affect supply and demand.

In other words, you have to look at different factors to determine whose economy is rockin’ like a Taylor Swift song, and whose economy sucks. You have to understand the reasons of why and how certain events like an increase in the unemployment rate affects a country’s economy and monetary policy which ultimately, affects the level of demand for its currency.

The idea behind this type of analysis is that if a country’s current or future economic outlook is good, their currency should strengthen. The better shape a country’s economy is, the more foreign businesses and investors will invest in that country. This results in the need to purchase that country’s currency to obtain those assets.

In a nutshell, this is what fundamental analysis is:

For example, let’s say that the U.S. dollar has been gaining strength because the U.S. economy is improving. As the economy gets better, raising interest rates may be needed to control growth and inflation.

Higher interest rates make dollar-denominated financial assets more attractive. In order to get their hands on these lovely assets, traders and investors have to buy some greenbacks first. As a result, the value of the dollar will likely increase.

Later on in the course, you will learn which economic data points tends to drive currency prices, and why they do so. You will know who the Fed Chairman is and how retail sales data reflects the economy. You’ll be spitting out interest rates like baseball statistics.

But for now, just know that fundamental analysis is a way of analyzing the potential moves of a currency through the strength or weakness of that country’s economic outlook. It’s going to be awesome, we promise!

 

Which Type of Analysis for Forex Trading is Best?

Ahhhh, the million dollar question….

Throughout your journey as an aspiring forex trader you will find strong advocates for each type of analysis. Do not be fooled by these one-sided extremists! One is not better than the other…they are all just different ways to look at the market.

At the end of the day, you should trade based on the type of forex analysis you are most comfortable and profitable with.

To recap, technical analysis is the study of currency price movement on the charts while fundamental analysis takes a look at how the country’s economy is doing.

In order to become a true forex master you will need to know how to effectively use these two types of forex market analysis.

Don’t believe us?

Let us give you an example of how focusing on only one type of analysis can turn into a disaster.

  • Let’s say that you’re looking at your charts and you find a good trading opportunity.You get all excited thinking about the money that’s going to be raining down from the sky.You say to yourself, “Man, I’ve never seen a more perfect trading opportunity in GBP/USD. I love my charts. Mwah. Now show me the money!”
  • You then proceed to buy GBP/USD with a big fat smile on your face (the kind where all your teeth are showing).
  • But wait! All of a sudden the trade makes a 100 pip move in the OTHER DIRECTION! Little did you know, one of the major banks in London filed for bankruptcy! Suddenly, everyone’s sentiment towards Britain’s market turns sour and everyone trades in the opposite direction!
  • Your big fat smile turns into mush and you start getting angry at your charts. You throw your computer on the ground and begin to pulverize it. You just lost a bunch of money, and now your computer is broken into a billion pieces.And it’s all because you completely ignored fundamental analysis .