Forex analysis is important to every trader. It is the best way to determine when to buy or sell a currency pair. There are two basic types of Forex market analysis which we will discuss in this lesson. They are: Technical and Fundamental Analysis
Technical analysis relies only on the price charts. It shows what is happening in the market now and what happened earlier. Fundamental analysis is more of an explanation of why there was a change in price or which fundamental factor led to it. Let us take a proper look at both types of Forex analysis.
TECHNICAL FOREX ANALYSIS
Experts base the technical analysis on three assumptions:
The first one is that everything about the market reflects in the price. It means the price of a currency pair reveals all information including economic and political factors. So there is a need to focus only on the price chart
The second is that price moves in trends. Once you have identified a trend on the chart, the price will more likely continue in the same direction as the trend rather than go against it.
The third assumption is that history repeats itself. The patterns on the price chart now where there earlier. To make a forecast for the future, you need to find a similar situation on the chart in the past and see how it turned out.
In simple words, technical analysts study the past to predict the future. Such a Forex analysis works because market participants react to price movement same way every time. Here, history repeats itself.
Types of Charts for Technical Forex Analysis
A line chart is the simplest type of chart as it represents only the closing price on each day over a set period. Date and time show up along the bottom of the chart and prices are seen along the sides.
The advantage of a line chart is its simplicity and the fact it provides an uncluttered easy-to-understand view of the asset’s price over a period. The disadvantage associated with using a line chart is that it does not provide visual information about the trading range for the individual points, such as the high/low of the opening and closing prices.
A bar chart displays the opening and closing prices including the highs and lows for the trading period. If you look at the bar chart, you can see that the vertical bar represents the high and low for the trading period.
The top of the bar represents the highest price and the bottom, the lowest price. The open and close appear on the vertical lines marked by a horizontal dash. Opening prices can be seen as a dash on the left side of the bar. The dash on the right side represents the closing price.
Candlestick charts show the same information as a bar chart but differently. The candlestick chart shows the high to the low range with a vertical line. However, the larger block in the middle, known as the body shows the range between the opening and the closing prices.
The wick of the candlestick shows the day’s full range, which is the high and low. If the body, which is red or sometimes black, appears in full, the currency pair closes lower than the opening price.
A green or sometimes white body means the closing price of a currency pair is higher than the opening price. A long green body shows the Bulls are in charge while a long red body signifies the Bears are in control of that session. Each candlestick will represent one period, for example, a day, an hour, a minute depending on a time frame you have set.
The advantage of the candlestick charting is they are easy to use and easy to interpret. It is a good way for beginners to execute technical Forex analysis. As with other forms of charting, traders use the candlestick in all time frames, from those looking for long-term investments to those who are swing or day traders.
FUNDAMENTAL FOREX ANALYSIS
Knowing why the price of a currency pair moved in a certain direction is the key to predicting where it will go next. Currency exchange fluctuates due to a set of different factors, such as economic growth, unemployment rate, and inflation.
Central banks have vast information about the country’s economy and they take these data into account while making their policy decisions. The main thing you should watch is the central bank’s interest rate as it can determine if investors will buy that currency.
If the interest rate of a currency is high, investors from abroad may move their money into that currency to earn interest on their investment. Demand for this currency increases and the exchange rate goes up. If there’s a low-interest rate on that currency, investors from abroad may look elsewhere or it may encourage investors who live in that country to spend their money instead of keeping it in the bank. Demand for this currency decreases and its exchange rate goes down.