The Forex trading market is an around-the-clock cash market where the currencies of nations are bought and sold, typically via brokers. For example, you buy Euros, paying with U.S. Dollars, or you sell Canadian Dollars for Japanese Yen. Forex prices can change at any moment in response to real-time events, such as political unrest, crude oil prices, inflation, import and export prices, or industrial production.
Currency market players typically use “Forex analysis” as a tool in predicting currency price movements. Forex analysis itself is divided into two types: fundamental and technical. Fundamental analysis uses economic and political factors as a means of predicting currency movements. Technical analysis uses reliable historical data as a means of forecasting these movements. The purpose of this article is to discuss the basic principles of fundamental and technical analysis.
Fundamental analysis uses economic and political factors, such as housing starts, the unemployment rate, or inflation, as a means of predicting currency movements. Fundamental analysis is concerned with the reasons or causes of currency movements. Many Forex traders who rely on the fundamental analysis plan their trading strategies around a number of key U.S. Government economic indicators. Some of these indicators are the Gross Domestic Product (GDP), Foreign Exchange Rates, Import and Export Prices, Industrial Production/Capacity Utilization, the Composite Index of Leading Indicators, Consumer Credit, the Consumer Price Index (CPI), Retail Sales, Housing Starts, the Employment Cost Index, and Consumer Confidence.
All of these Federal economic indicators have a marked effect on both the stock market and Forex. Some of these indicators are released weekly, while others are released monthly or quarterly. Their sources include the Federal Reserve Board, the U.S. Bureau of Labor Statistics, the U.S. Department of Agriculture, the U.S. Bureau of Economic Analysis (BEA), and the U.S. Census Bureau.
Forex traders must take other economic indicators into consideration as well. The world’s leading economies (for example, the United Kingdom, Japan, France, and Germany) also release their own economic indicators that will have an impact on the Forex market. For example, leading economic indicators in the United Kingdom include Housing Prices, Gross Domestic Product (GDP), Vehicles per 1,000 People, Telephones per 1,000 People, and the Percentage of People Employed in Agriculture.
Technical analysis uses historical data as a means of predicting currency movements. The technical analyst believes that history repeats itself over and over again. Technical analysis is not concerned with the reasons for currency movements (for example, interest rates or inflation). Instead, it believes that historical currency movements are a clear indication of future ones.
Investopedia states that “In a shopping mall, a fundamental analyst would go to each store, study the product that was being sold, and then decide whether to buy it or not. By contrast, a technical analyst would sit on a bench in the mall and watch people go into the stores. Disregarding the intrinsic value of the products in the store, his or her decision would be based on the patterns of activity of people going into each store.”
For example, during the back-to-school buying season, the technical analyst might observe that more people are going into clothing stores than into stores selling flowers. Likewise, the technical analyst might observe that more men are going into stores selling flowers on Valentine’s Day than into clothing stores.
Here is another example. Oil prices dramatically increase, thus creating inflation. Interest rates rise as a means of controlling inflation. One historical result of higher interest rates is less money to spend, thus slowing economic growth. Another historical result is increased foreign investment in the currency affected by the higher interest rates, thus strengthening it.
The technical analyst typically uses charts as a tool for predicting currency price movements. The three most popular kinds of charts are line charts, vertical bar charts, and candlestick charts.
Some Forex traders depend on fundamental analysis while others depend on technical analysis. However, many successful Forex traders use a combination of both strategies. However, the important point to remember here is that no one strategy or combination of strategies is 100% certain.