3 Types of Forex Market Analysis

 

The Forex market is a global marketplace where various international currencies are traded freely. In this digital marketplace, participants, i.e. individual traders, businesses, banks, and governments—engage in currency transactions, setting exchange rates for each currency pair.

Emerging in the early 1970s after the collapse of the Bretton Woods agreement, the Forex market met the need for a platform facilitating currency exchange. Unlike other financial markets, Forex operates globally over computer networks, linking major economic hubs.

Understanding different patterns to analyse the forex market is crucial for any trader. In this article, we explain the three types of forex market analysis: Fundamental Analysis (FA), Technical Analysis (TA), and Sentiment Analysis.

Understanding the Types of Forex Market Analysis

Fundamental Analysis

Fundamental Analysis in forex is like investigating the DNA of currency trading while looking at key factors that influence a currency's value. Simply put, it's about grasping the essentials that drive the forex market.

Fundamental Analysis is a practical investigation that goes beyond daily price fluctuations. It assesses a currency's value by delving into economic, financial, and critical factors. It's a long-term focus.

FA starts with economic indicators like GDP growth, inflation, and employment rates. It then scrutinises financial statements - the balance sheet, income statement, and cash flow statement. Interest rates, controlled by central banks, also play a vital role. Lastly, qualitative factors like government management and economic strengths come into play.

If a country's GDP is booming, unemployment is low, and the government is financially savvy, its currency is likely substantial. Conversely, if a country is drowning in debt and economic indicators are bleak, its currency might struggle.

FA is a compass in the forex market. Strong fundamentals suggest a robust currency. Traders use FA to decide where to invest for the long term.

Unexpected geopolitical turmoil or economic surprises can disrupt even the best FA predictions.

Recommended Read: Common Forex Myths to Know

Technical Analysis

Technical Analysis in forex trading involves studying past market data, specifically focusing on statistical trends like price and volume. It seeks to predict future price movements by identifying patterns and using indicators derived from historical trading data.

TA operates on the belief that all known information is already reflected in a security's price. It analyses price charts, patterns (like head and shoulders or trend lines), and technical indicators (such as moving averages, RSI, and MACD). Volume, representing the number of traded shares or contracts, is also a key factor.

Examples of Technical Analysis

Price Patterns: This involves identifying shapes like the head and shoulders of a price chart, double tops and bottoms.

Indicators: This involves using tools like moving averages to smooth out price data or RSI to measure overbought or oversold conditions.

Volume Analysis: This includes assessing the number of shares or contracts traded during a specific period.

Various approaches include trend analysis, focusing on market direction, candlestick patterns predicting future price movements, and momentum indicators measuring the speed of price changes.

Traders use TA for short-term signals, determining entry and exit points. For instance, if a currency pair's price breaks above a resistance level on high volume, it may indicate a bullish trend.

While powerful, TA isn't foolproof. Market conditions can change abruptly due to unexpected events or economic indicators, deviating from historical patterns.

Sentiment Analysis

Sentiment Analysis in forex trading is about how traders collectively feel about a specific currency pair or the whole forex market.

It's a way to understand whether traders generally feel optimistic (bullish) or pessimistic (bearish) about a currency's future price movements.

In simple terms, it's like reading the mood of the market. It helps us know if most traders expect a currency to go up or down, influencing potential price changes.

It looks at traders' positions—mostly buying (net long) or selling (net short). Tools like Commitment of Traders (COT) reports show these positions.
 

• If many are buying, it suggests bullish sentiment.
• If selling, it suggests bearish sentiment.

Picture a big move in GBP/USD after a significant event like Brexit. If negative sentiment sends GBP plummeting, it's a bearish signal. Conversely, if sentiment improves and GBP rises, it's bullish.

Sentiment Indicators include:

Net Traders Positions:

It tells if traders buy or sell a currency pair during a season.

High/Low Sentiment Ratio:

It shows the number of buyers versus sellers trading currencies in the market.

Market News and Events:

This takes into consideration how traders might react to news or economic releases.

Traders might use it as a contrarian signal. For instance, if most traders are bullish on EUR/USD, a contrarian might go short, expecting a reversal. This strategy relies on the idea that if everyone is positioned one way, the market might move the opposite.

Market sentiment can quickly change due to economic indicators, news, or unexpected events. Use it and other analyses like Technical and Fundamental Analysis for a more innovative trading strategy.

Which Method Should BitDelta Traders Use?

There's no one-size-fits-all answer for all traders. Choosing the proper market analysis for your trades depends on your strategy. However, if you're patient and would be trading for the long haul, FA might be an excellent option.

If you enjoy quick moves and short-term gains, you can stick to technical analysis. On the other hand, sentimental analysis is excellent if you apply psychology to how other traders trade and the market movements.

You should know that many successful traders don't use just one market analysis. They use fundamental analysis to pick what to trade, technical analysis to decide when to trade, and sentiment analysis to double-check the market's mood. Knowing how to use these analyses can help you make better trading decisions.