Jayden Everyone can profit from the Forex market. How convenient it is to participate in this market and enjoy the tax benefits, magnified leverage and 24-hour trading hours. The next step is to figure out how the Forex market works. Once you understand why the forex market works the way it does, you can get your foot in the door to make money in forex.
In the Forex market, professionals use two methods of analysis to assess the current state of the market and determine its future direction. These two methods are fundamental analysis and technical analysis. These two methods are the two basic types of analysis in forex trading.
Fundamental analysis focuses on the factors that drive changes in exchange rates, while technical analysis focuses on the behaviour of the exchange rate itself.
1. Fundamental analysis
Fundamental analysis focuses on the economic, social and political aspects that affect supply and demand in the forex trading market. In other words, you check which country’s economy is better and which one is worse. The main idea is that if a country’s economy is doing well, then its currency must also be strong. This is because the better a country’s economy is, the more other countries trust their currency.
For example, if the US economy continues to perform well, and as the economy booms and interest rates rise in order to curb excessive inflation, then the dollar will move up and the US dollar will be strong. There are two reason, the US economy is doing well and the US interest rates are high. The former is like a company with high earnings per share and the latter is like a company with high dividends. In simple terms, this is the common principle of fundamental analysis.
Fundamental analysis is the study of all the factors that affect the economy to which each currency belongs. For example, inflation rates and crude oil prices affect the U.S. economy and thus the value of the U.S. dollar.
As for how individual fundamental factors will affect the value of the US dollar, we will discuss that later. What is important to know here is that the US dollar usually reacts predictably to changes in fundamental economic factors. If you know what these reactions will be, you can easily make a profit.
Now, it is only necessary to understand that fundamental analysis is used to infer currency movements by analyzing the strength and political stability of a country’s economy.
2. Technical analysis
Technical analysis focuses on the movement of prices. In simple terms, technical analysis equates to the study of price charts. The basic idea is that we can extrapolate future price movements by looking at historical price movements. By looking at price charts, you can identify trends and patterns, and both can provide us with trading opportunities.
Technical analysis studies the movements of currency prices on the charts. Using a chart is an effective way to condense everything that is happening in the Forex market into a simple and easy to use form.
For example, if the price is getting higher on the chart, then it is more likely to continue to rise unless something happens to change its trend. It’s like Newton’s first law of motion – an object in motion will remain in its previous state of motion unless it is affected by an external force. Technical analysis helps you identify the current direction of price movement and determine when it will change direction.
The most important thing in technical analysis is the trend! Many people used to say, “The trend is your friend.” This is because once you catch a trend, you will soon make a fortune. Technical analysis helps you to identify trends as they form and gives you excellent trading opportunities.
3. Which method is better?
After many years of experience as a trader, you will find that both schools of thought have many staunch advocates. There are traders who are technically inclined, and there are traders who are fundamentally inclined.
You will find some who argue that fundamentals are driving the market, and the patterns found on the charts are nothing more than coincidences.
But the other group will argue that technical analysis should get the attention, because price absorbs all the information. And many graphs do help us to predict market movements.
What I will tell you is that you need to know a little bit about both. Both fundamental and technical analysis helps you to make profits in the Forex market.
We think that if you can master both types of analysis, why not use both? If you use all the tools available to you, your chances of success will definitely be greater.
In order to become a true master of forex trading, you need to know how to apply both types of analysis effectively. You don’t doubt my statement, do you? Let me give you an example of the disastrous consequences of limiting yourself to only one type of analysis for trading.
Suppose you look at your forex charts and find a great trading opportunity. You are so excited that it seems like money is falling from the sky. Then you build up your position with a smile on your face.
However, the market suddenly moves 30 pips in the opposite direction of your position! It turns out that the currency you were building has announced a decision to cut interest rates, which you knew nothing about, and traders are selling the currency as soon as the news is released.
Your facial expression becomes angry and tense and you start to get angry at your charts. You slap your computer keyboard so hard that you want to break it. This is all because you have ignored fundamental analysis.
Well, there’s a bit of drama and exaggeration in this story, but I think you’ve grasped the significance of it.
In fact, this view is still true in the forex market. Don’t rely too much on one type of analysis, instead, you should learn to strike a balance between the two, because only then will you be able to maximize your trading potential.
