- Three general forms of analysis that traders use
- Find one or a combination of styles that fits your personality
- Try identifying trades by using the analytical style in a forex practice account
There are several different ways to analyze the FX market in anticipation of trading. Though categories of analysis may be plentiful, keep the end goal in sight which is to use the analysis to identify good trading opportunities.
We will look at the three main areas of analysis and how to learn more about them. Then, try out each of these areas to determine which of the three methods or combination of the methods works well for your personality. The three areas are:
Forex fundamental centers mostly around the currency’s interest rate. Other fundamental factors are included such as Gross Domestic Product, inflation, manufacturing, economic growth activity. However, whether those other fundamental releases are good or bad is of less importance than how those releases affect that country’s interest rate.
As you review the fundamental releases, keep in mind how it might affect the future movement of the interest rates. When investors are in a risk seeking mode, money follows yield and higher rates could mean more investment. When investors are in a risk adverse mentality, then money leaves yield for safe haven currencies.
The DailyFX.com website offers a lot of assistance on identifying how a fundamental release could affect the value of the currency. Check out the economic calendar for events coming up this week.
Forex technical analysis involves looking at patterns in price history to determine the higher probability time and place to enter and exit a trade. As a result, forex technical analysis is one of the most widely used types of analysis.
Since FX is one of the largest and most liquid markets, the movements on a chart from the price action generally gives clues about hidden levels of supply and demand. Other patterned behavior such as which currencies are trending the strongest can be obtained by reviewing the price chart.
Other technical studies can be conducted through the use of indicators. Many traders prefer using indicators because the signals are easy to read and it makes forex trading simple.
Technical versus fundamental analysis in forex is a widely debated topic. There is no one right answer but I’m confident you’ll find a style that fits your personality.
Forex sentiment is another widely popular form of analysis. When you see sentiment overwhelmingly positioned to one direction that means the vast majority of traders are already committed to that position.
Perhaps this could be more easily explained with an example. Let’s assume that an overwhelming amount of traders and investors are bullish the Euro. They think the Euro is going higher. Since people vote with their trades, we can assess through DailyFX, which shows the IG Client Sentimentthat the EUR/USD sentiment shows a majority of traders are buyers in the currency pair.
Since we know there is a large pool of traders who have already BOUGHT, then these buyers become a future supply of sellers. We know that because eventually, they are going to want to close out the trade. That makes the EUR to USD vulnerable to a sharp pull back if these buyers turn around and sell to close out there trades.
Learn more about sentiment trading through DailyFX to provide trading opportunities based on IGCS.
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---Written by Jeremy Wagner, Head Trading Instructor, DailyFX Education
Follow me on Twitter at @JWagnerFXTrader.
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