Analyzing The Forex Market

There are so many Forex trading strategies out there that it’s not surprising so many people don’t know where to start when analyzing the forex market. But actually, all of those strategies are a combination of two different analysis techniques: fundamental analysis and technical analysis.

A fundamental analyst looks at a nation’s entire financial picture to guide her trades, studying international macroeconomics and the forces that drive the supply of and demand for a currency. There are five of these factors:

• Is that country’s government in good financial shape or in the red, and what is their financial policy (pro-business, labor, etc.)
• The balance of imports versus exports, which directly affects a nation’s money supply
• The growth of that country’s real gross domestic product (GDP); in other words, that nation’s purchasing power
• Interest rate levels
• Inflation level; in other words, how high are prices

These last three are all relative, which means they are compared to those same measurements for other countries to determine their strength or weakness, rather than considered as stand-alone numbers.

The fundamental analyst looks at all these factors and balances them against each other to determine whether a nation’s currency will appreciate or depreciate. Of course, as the Forex market trades the currency of one nation against that of another, the fundamental analyst cannot simply study the economic picture of one country; she must study both of them, and then compare them to determine which paints a more compelling financial picture.

The technical analyst, on the other hand, looks only at the charts. He looks at the price of a currency pair (or any other commodity, such as oil prices or stocks) and sees how it has varied through time, examining the patterns it has drawn with an eye to predicting what it might do in the future.

Technical analysis is flexible. It works the same way in any market with charts (Forex, stocks, commodities, etc.). Once you learn how it’s done, you can apply it in other markets and get the same results.

Fundamental analysis, on the other hand, is not flexible, because it looks at the economic data for each nation individually. The financial numbers for Great Britain, after all, have nothing to do with those for Japan or New Zealand, and the fundamental analyst cannot take her studies to another market. She must study one currency pair and learn its two nations’ economies intimately if she is to be successful with this technique.

That said, fundamental analysis is good for understanding what ought to happen and for predicting the long-range trend of a currency pair. It’s also true that many profitable trades are made immediately after economic announcements, when savvy traders jump into the market while everyone else is still gasping over the numbers.

On the other hand, technical analysis can give you a specific strategy for a trade, including entry and exit points and where to place your stops. It requires less time to learn than fundamental analysis, and works well for shorter trends and individual trades.

The most successful traders use a combination of these two techniques, combining chart analysis with the timing provided by economic announcements to get the best of both worlds.