FOREX ANALYSIS: FUNDAMENTAL AND TECHNICAL
There are many tools and techniques that can be considered for analysis before opening trades in the forex market. To maximize your profits, it is necessary to find an optimum investment point by executing different types of forex analysis before or during your trading positions. The best analysis is not based on forex fundamental analysis only. You cannot achieve your desired analysis by using technical analysis only. The fundamental analysis gives the reason and technical analysis shows the direction of a trade, so it will be more efficient when you will use a combination of both.
In this article, you will learn about the following topics:
- What is technical analysis?
- History and Basic concepts
- Main principles of Technical Analysis
- Fundamental Analysis
- Forex Technical Analysis VS Fundamental Analysis
Every professional forex trader must perform a detailed analysis to determine the best entry and exit points before trading on the forex platform. Technical analysis is based on predicting the future position of the market using graphs, past behaviors, and different theories.
According to technical traders “everything on the left side of the chart is free information”. They can interpret and trace the prices based on previous data while making trades.
Before this technology revolution, traders were writing prices on papers and draw charts by hand. But nowadays technical indicators, trading theories, oscillators are facilitating the traders to forecast prices. Technical analysis is very helpful to set stop-loss and take profit for any trade.
History of Technical Analysis
The United States of America is the place where speculation began for the financial world by recording market prices and spotted patterns. The years between the 1800s and middle 1900s were very important; the theories and analysis of today derived from that period including:
- Dow Theory – 1800’s
- Point and Figures – 1900’s
- Gann Theory – 1920’s
- Gartley – 1940’s
- Elliott Waves Theory – 1940’s
The trend of technical analysis was changed from the mathematical formulas to technical indicators when computers appeared and become available for personal use. Using these different types of technical indicators, forex traders use multiple theories and methods including trend lines, channels, divergences support, and resistance, etc. to understand the complex forex charts.
Basic Concepts of Technical Analysis
Forex charts play a vital role in technical analysis to predict the price movements. Forex experts who use the charting method believe that market movements are not haphazard and can be predicted through various tools used in technical analysis, as well as past trends. Some of the methods used in graphing are trends, support and resistance points, and channels.
An important part of the technical analysis is to identify predictable trends. The price trends consist of continuous movements of the exchange rate in a certain direction. Traders take the time to buy a pair when it goes up and sells it when it goes down.
Three generally preferred trends are up, down and horizontal trends. Uptrends consist of increasing peaks and bottom points. Upward trends are drawn along rising bottom points.
When the pair approaches the lower limit of the upward trend line, you are likely to have a chance to buy. On the other hand, a reversal from the top of the rising trend may indicate a sales opportunity.
The downtrend consists of decreasing peaks and bottom points. The downward trend line is drawn along the decreasing peaks. When the pair approaches the upper limit of the downtrend, you are likely to have a sales opportunity. On the other hand, a backward turn from the bottom of the downward trend may indicate an opportunity to buy.
Finally, horizontal trends are those in which the price shows unstable volatility without moving in a certain direction.
Support and Resistance Points
Support and resistance points are terms commonly used by technical experts to define specific price ranges. In short, the support and resistance points are the upper and lower points of the pair’s possible range of movement.
The support point is the point where the pair is supported upwards by applying market support to the falling price in a chart. The reason for this happening is that the majority of market players believe that the pair will move upwards after this level, and therefore the pair is supported from this point.
The point of resistance is the point at which a pair is pushed downwards by applying resistance to the rising price on a chart. The reason for this event is that the majority of market players believe that the price will perform downward movement after this level. Therefore, the pair has seen “resistance” at this point.
Both support and resistance points depend entirely on human psychology. The reason for the existence of these points is that the market players believe in them and act in this direction that is, buying from the support point and selling from the resistance point.
Forex charts have three types of channels: rising channel, descending channel and horizontal channel. In the rising channels, the peaks and bottom points gradually increase. In the descending channels, the peaks and the bottom points gradually decrease. In horizontal channels, the market varies.
Indicators in money markets are very important to understand the fluctuation of prices. Below you will find some of the main indicators used in technical analysis.
Stochastic indicators help to understand speculative trading in money markets. The display range is 0 to 100. It is understood that speculative purchase occurs when the predicted indicator goes above 80, and speculative sales occur when the indicator falls below the 20 levels. Those who wish to capture trading opportunities in the market through stochastic should take care to take a long (buy) position when the indicator falls below 20 and a short (sell) position when the indicator rises above 80. For example, if the indicator remains around 80 for a period of time, a downward movement is very likely within a very short time.
The Parabolic SAR (Stop And Reversal) indicator is often used by technical analysts to determine the endpoints of market trends. In the parabolic SAR method, certain points are placed below or above the current price to see opportunities. If the indicator places points below the current price, investors should take long positions. On the other hand, if the indicator places the points above the current price, it is indicated on a downward trend and thus investors should take short positions.
Relative Strength Index (RSI)
The Relative Strength Index is commonly referred to as the RSI abbreviation and is similar to the stochastic indicator. The reason for this similarity is that it helps to determine speculative trading in the RSI indicator. The RSI also takes values between 0 and 100. When the indicator rises above level 70, it is understood that the pair have been purchased too much, which in turn indicates a downward trend. On the other hand, when the indicator drops below the level of 30, it is understood that the pair has been sold more than necessary, indicating an upward trend.
Moving Average Convergence Divergence (MACD)
Moving Average Convergence Divergence is a popular and useful technical analysis tool used as an indicator of MACD, trend or momentum. This indicator generally reveals the relationship between the moving averages of prices. The MACD is calculated by the difference between 12 and 26 Exponential Moving Average (EMA).
Note that the previous moving average is faster than the next moving average. The difference between these two moving averages is indicated by a single line. This line is called the MACD rootstock. In many cases, the MACD indicators include another line, which is the moving average of the baseline, and this line is assigned the default setting 9 on most processing terminals.
This single line is important in terms of showing the turning points in the markets. The numbers 12, 26 and 9 are usually the default settings for this indicator, but the numbers can be changed at the user’s discretion. The point at which the fast and slow-moving averages intersect determines the point at which to enter or exit the current market. Since the two moving averages move at different speeds, it is inevitable that the fast one will react much faster to the price action than the slow one. The points at which these averages intersect, give us a trading signal.
Moving averages are a technique used to regulate price actions in international money markets. These indicators reduce irregular movements in the market and help you identify potential opportunities in charts more easily. Moving averages are divided into two main types as simple moving averages and exponential moving averages (EMA).
Simple moving averages are the most commonly used moving averages. Simple moving averages are obtained by dividing the number that occurs after the closing prices of a certain number of repetitive time intervals (e.g. X times) into any number of time intervals. Investors like simple moving averages because they help them measure the current market movements and see the big picture so that the entry and exit points of the transaction are determined. The other moving average type is the exponential moving average. Exponential moving averages are almost the same as simple moving averages. The only difference is that exponential moving averages focus more on current market events.
Bollinger bands are used by technical analysts to measure the volatility of Forex markets; thus, whether the market has volatility, i.e. the activity level of the market, is determined. Bollinger bands consist of three lines: upper, middle and lower bands. The middle band is a simple moving average. The top and down bands are used to calculate deviations. These bands approach each other as the activity level in the market decreases; as the level of activity in the market increases, they move away from each other. One of the most important features of Bollinger bands is that prices generally tend to the middle of the bands; thus, the price returns to its middle position after touching the up and down bands. Also, when the bands are very close to each other, the tapes are usually broken, so the price goes out of the tapes.
Three Main Principles of Technical Analysis
- Market movements are determined by the market.
Technical analysts believe that all major situations that may affect a currency will be reflected in price movements.
- Market movements are based on trends.
Technical analysts believe that the movements in the markets are both systematic and easy to read and in a certain order. There are three trends: up, down and horizontal.
- “History is repetition”.
The changes in the prices of international money markets over the years are recorded in various databases. In the studies conducted in accordance with these databases, it is understood that certain movements seen in the graphs repeat itself. Therefore, technical analysts are dealing with the belief that past movements will repeat themselves in the future.
Basic analysis; economic, social and political factors and the effects of these factors on the value of currencies are a kind of market analysis. Traders, who use basic analysis to provide insight into when and how they will trade, believe that the value of a currency depends on macroeconomic balances. This means that the currency of a country with a strong economy is more valuable than the currency of a weak economy. Important political events and economic news can lead to major movements in the Forex markets. By analyzing this news well, you can better understand the market and predict market movements. When evaluating the data in the economic calendar, you should compare these results with current results, taking into account previous results and forecasts. Movements in the market; occur when there is a discrepancy between expectations and current results as a result of past results and forecasts. Below is a description of some of the key data that have led to movements in the Forex markets.
The interest rate is perhaps one of the most influential factors in currencies. It is also important to note that each currency unit is an “overnight interest rate set by the central bank of the nation concerned. Low-interest rates cause a nation’s currency to weaken and high-interest rates strengthen. If a country’s central bank raises interest rates, the profit on holding this currency increases so that the currency becomes more attractive. As a result, the value increases. On the other hand, if a central bank cuts interest rates, the currency loses its appeal. As a result, the value decreases.
Growth indicators provide information about the economic situation of a country. If the indicators are positive, that is, there is an increase in the economic dimension; the situation of that country is improving. Naturally, this situation will attract investors and increase the value of the currency. Some of the growth indicators closely examined by the players include Gross Domestic Product (GDP), Gross National Product (GNP), Consumer Price Index (WPI-CPI), construction indices, private enterprise investments, and public expenditures.
Inflation indicates an increase in the price range of products and services in a particular region. Inflation indicators such as the Consumer Price Index (WPI-CPI) generally point to a country’s economic growth. Central banks carry out certain controls and interventions to prevent inflation rates from getting out of control. In countries with high inflation rates, purchasing power is low, which means that the currency of the country is weak. In order to increase the value of the currency, interventions such as raising interest rates by the government may come.
Unemployment indicators are a sign of the state of a country’s economy. If the number of people working in a country is increasing, the economy of this country is expanding. On the other hand, if there is no significant increase in the number of people working in the country, this indicates that the country’s economy is not meeting expectations, which may lead to a weakening of the currency. For example, the monthly non-farm salary report published in the US plays an important role in determining the strength of currencies in foreign markets.
Balance of Payments Report
The balance of payments report reveals the difference between a country’s imports and exports. If a country’s exports are more than imports, the currency will probably be strong. Conversely, the currency will be weak.
Forex Technical analysis VS Forex Fundamental Analysis
- The technical analysis concept can be used in any market while forex fundamental analysis doesn’t. Forex fundamental analyses are specific to the forex market.
- Forex technical analysis uses price movements to predict future prices and fundamental analysis explains which economic factors caused the price moves.
- Usually, forex technical analysis used by short-term day traders and fundamental analysis are used by long-term position traders.
Macroeconomic traders don’t care about regular economic news they consider forex fundamental analysis on big scales only whereas scalper traders avoid opening trades when major economic news become released.
Many forex traders build expert advisors, robots, and automated scripts of different programs using forex technical analysis to buy or sell currency pairs on certain conditions.
Always remember, you can lose your invested capital using both types of analysis if you don’t have any proper money management system.