It is true to state that the aim of trading on the foreign exchange market, like every other trade out there is to make a profit. For this reason traders, especially the new ones, need to understand the various techniques and tools needed to trade on the forex market. Like every trade, if you do not fully understand what you have gotten yourself into, you will quickly run at a loose. To prevent this from ever happening, we have taken a painstaking effort to explain to you the various techniques used by every broker out there to analyze the forex market before making trades.
What is market analysis?
To analyze the market simply means to gather all information about activities that affect the market,in this case the forex market, before arriving at a decision to buy or sell. One may ask, what are some of these activities that affect the fx market? In truth, there are numerous factors that affect the forex market. Among them are central bank monetary policies, trade flows and trade balances, government, economic growth and outlook, capital flows, inflation rates, interest rates, government debt, speculation, changes of foreign reserves and natural disasters just to mention a few.
Monetary policies of a country
The central banks of countries also play major roles in the forex market. These banks interfere either to raise or lower the value of their own currency by controlling the inflation rates, interest rates and the money supply. In order to stabilize the market at an ideal level, use foreign exchange reserves by buying and selling the local currency.
One notorious example is Japan. As an export-oriented economy, the central bank employs various currency devaluation strategies to boost competitiveness in global trade..Even though such policies effective lower the value of the domestic currency, the resulting export growth seems to justify the effort.
The governments of the major countries can have both negative and positive effect on the forex market. This is because the currencies of these countries are amongst the most traded securities on the forex market. These countries include United States Of America, Canada and many more. Factors like instability, debt and many more affect the stability of their currencies ego affecting the forex market.
This is a national debt owed by the central government. A country will less likely go for foreign capital leading to inflation. Foreign investors will also begin to sell their bonds in open market if a government debt is predicted. This will eventually lead to a decrease in the value of the exchange rate for the currency of that country.
A change in government and other factors can cause instability in a government. This will have a direct effect on the economy. And any impact to the economy either good or bad will eventually affect the exchange rate.
The various techniques used to analyze the forex market
These are methods that have been used by both professional and amateur traders alike. Since the forex market is decentralized, no single person, organization or government has an autonomic control over it. Ego the need for these techniques to help you make the right decision as to what and when to trade because anything can happen anytime on the flow forex market. It is important to remember that these techniques are based on facts about the movements of securities on the market.
There are three methods of analysis namely,
- fundamental analysis
- technical analysis
- sentimental analysis
Some traders combine all these methods of analysis to make their trading decisions and some are inclined to just one. It all depends on what makes you comfortable.
What is technical analysis?
The technical analysis of the financial market is the use of price patterns, charts and indicators to make trading decisions. The technical analyst basically uses the history of price patterns of securities to make his decisions to trade. The technical analysis of the financial market was founded based on Dow theory. The two basic assumptions of Dow theory that form the basis of technical analysis are
- A) The market price discounts all factors that may influence the price of a security.
- B) The movements of market prices are not purely random but rather they move in identifiable patterns that are bent to repeat themselves over time.
The assumption that the market price discounts all factors that may influence the price of a security implies that the price of any security at any point in time is a true reflection of all the available information and therefore represents the accurate value of that security. This is based on the idea that the market price always represents the total knowledge of all market participants.
The second assumption that the movements of market prices are not just random but rather they move in patterns that can be identified and are bent to repeat over time leads to the belief of a technical analyst that all market trends can be identified ego enabling traders to make profit from investing based on already existing trends.
How is technical analysis used?
It is generally used in predicting the price movements of virtually any trading instrument that is affected by the forces of supply and demand. It is mostly applied to the changes in prices but some analysts occasionally apply it on trading volume or open interest figures. With time, several technical indicators have been identified. Some are used mainly for identifying current market trends whilst some are used to determine the strength of a trend and its likelihood of continuation. Some commonly used indicators are the moving averages and momentum indicators. An example is the moving average convergence divergence (MACD) indicator. These indicators are applied to charts of different time frames.
The fundamental market analysis is the method of evaluating the price of currency by examining it’s related financial, economic and other factors that affect it. The difference between the technical market analysis and the fundamental market analysis is that technical analysis studies charts of price movements while fundamental analysis studies economic balance sheets of the country of a particular security. The end goal of fundamental analysis is to produce a value that can be compared with the current value of security thus showing whether a security is overvalued or undervalued.
Sentimental analysis simply attempts to understand the mood in the market, the thoughts of traders and their expectations. Sentimental analysis on its own is not enough standpoint basis upon which you should trade because just because the majority of traders are thinking the same thing about the price movement of security is not a guarantee that they will make a profit. On the market, each trader’s thought and opinions are expressed through the positions they hold and this helps form the overall market sentiment irrespective of whatever information is out there.
It is important as traders to remember that, no matter how you feel about a certain trade, you cannot make the market move in accordance with your expectations, so relying solely on sentimental analysis is never enough to justify any trading decision. Combining sentimental analysis with either the technical market analysis or the fundamental market analysis can greatly improve your chances of making profit.
In conclusion, it is very important for traders, especially the amateur ones, to know how to trade properly so they do not run at a loss. I know people who have had very bad experiences on the forex market due to lack of education and inexperience. They basically didn’t know what they were doing so their money got squandered. To protect yourself from such faith, you need to understand the different types of trading analysis available and the different tools available to you to trade with and choose which one makes you comfortable.