Forex analysis is used by retail forex day traders to determine buy or sell decisions on currency pairs.
Forex analysis could be technical in nature, using resources such as charting tools. It can also be fundamental in nature, using economic indicators and/or news-based events. The day trader's currency trading system uses analysis to determine buy or sell decisions when they point in the same direction. Automated forex trading strategies that incorporate technical and fundamental analysis are available for free, for a fee or can be developed by more tech-saavy traders.
Types of Analysis Used in Forex
Fundamental analysis is often used to analyze changes in the forex market by monitoring factors, such as interest rates, unemployment rates, gross domestic product (GDP) and many other types of economic data that come out of countries. For example, a trader conducting a fundamental analysis of the EUR/USD currency pair would find information on the interest rates in the Eurozone more useful than those in the U.S. Those traders would also want to be on top of any significant news releases coming out of each Eurozone country to gauge the relation to the health of their economies.
Technical analysis comes in the form of both manual or automated systems. Forex systems use past price movement to determine where a given currency may be headed. A manual system typically means a trader is analyzing technical indicators and interpreting that data into a buy or sell decision. An automated trading analysis means that the trader is "teaching" the software to look for certain signals and interpret them into executing buy or sell decisions. Where automated analysis could have an advantage over its manual counterpart is that it is intended to take the behavioral economics out of trading decisions.
Automated technical analysis and manual trading strategies are available for purchase through the internet. However, it is important to note that there is no such thing as the "holy grail" of trading systems in terms of success. If the system was a fail-proof money maker, then the seller would not want to share it. This is evidenced in how big financial firms keep their "black box" trading programs under lock and key.
There are three basic reasons for doing a weekend analysis. The first reason is that you want to establish a "big picture" view of a particular market in which you are interested. Since the markets are closed and not in dynamic flux over the weekend, you don't need to react to situations as they are unfolding.
Secondly, the analysis will help you to set up your trading plans for the coming week. Weekend analysis is akin to an architect preparing a blueprint to construct a building to ensure a smoother execution. Remember, shooting from the hip can leave a hole in your pocket! Finally, a weekend analysis helps build a routine so you can establish the necessary mindset for the upcoming week. (For further reading, see "9 Tricks of the Successful Trader.")
Forex Analysis: The Bigger Picture
Analysis can seem like an ambiguous concept to a new forex trader. Therefore, it's important to think critically about the tenets of analysis, which we've outlined in four steps below.
1. Understand the Drivers.
The art of successful trading is partly due to an understanding of the current relationships between markets and the reasons that these relationships exist. It is important to understand causation, remembering that these relationships can and do change over time.
For example, a stock market recovery could be explained by investors who are anticipating an economic recovery. These investors believe that companies will have improved earnings and, therefore, greater valuations in the future and it is a good time to buy. However, speculation, based on a flood of liquidity, could be fueling momentum and that good old greed is pushing prices higher until larger players are on board so that the selling can begin.
Therefore the first questions to ask are: Why are these things happening? What are the drivers behind the market actions?
2. Chart the Indexes.
It is helpful for a trader to chart the important indexes for each market on a longer time frame. This exercise can help a trader to determine relationships between markets and whether a movement in one market is inverse or in concert with the other.
For example, in 2009, gold was being driven to record highs. Was this move in response to the perception that paper money was decreasing in value so rapidly that there was a need to return to the hard metal or was this the result of cheap dollars fueling a commodities boom? The answer is that it could be both, or as we discussed above, market movements driven by speculation.
3. Is There a Consensus in Other Markets?
We can gain a perspective of whether or not the markets are reaching a turning point consensus by charting other instruments on the same weekly or monthly basis. From there, we can take advantage of the consensus to enter a trade in an instrument that will be affected by the turn. For example, if the USD/JPY currency pair indicates an oversold position and that the BOJ could intervene to weaken the yen, Japanese exports could be affected. However, a Japanese recovery is likely to be impaired without any weakening of the yen. (For further reading, see "The U.S. Dollar and the Yen: An Interesting Partnership.")
4. To Trade or Not to Trade
There is a much higher chance of a successful trade if one can find turning points on the longer timeframes then switch down to a shorter time period to fine-tune an entry. The first trade can be at the exact Fibonacci level or double bottom as indicated on the longer term chart, and if this fails then a second opportunity will often occur on a pullback or test of the support level.
Patience, discipline and preparation will set you apart from traders who simply trade on the fly without any preparation or analysis of mulitple forex indicators. (For more trading tips, read "The Most Reliable Indicator You've Never Heard Of.")
The Bottom Line
There is no "best" method of analysis for forex trading between technical and fundamental analysis. The most viable option for traders is dependent on their timeframe and access to information, while it does not hurt to conduct a weekend analysis when the markets are not in a constant state of fluctuation. For a short-term trader with only delayed information to economic data, but real-time access to quotes, technical analysis may be the preferred method. Alternatively, traders that have access to up-to-the-minute news reports and economic data may prefer fundamental analysis.
For more on this topic, see "Forex Trading Strategy."
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