Operating in the huge foreign exchange or forex market usually requires using at least market analysis to make a trading plan profitable. Many forex traders use several complementary market analysis methods to achieve success. This article discusses the best forms of forex analysis and how traders use them to achieve better currency trading results. You can read more from Benzinga on forex trading.
What does a Forex analyst do?
Typically, a forex analyst performs a detailed examination of the factors that can move the currency market or potentially predict its future path. Many successful forex traders attribute their profitability to the quality of the market analysis they perform. Forex market analysis can also help you structure your thoughts and observations regarding the forex market to come up with an actionable trade idea.
Three Types of Forex Analysis
Profitable forex traders typically analyze the outlook for the currency market in one or more of three basic ways to determine whether to go long, short, or neutral on a particular currency pair. These common market analysis methods consist of technical, fundamental and sentiment analysis, and each method is described in more detail in the sections below.
The most popular method of market analysis among currency trading professionals is forex technical analysis. This method assumes that market exchange rates update all available information, which greatly simplifies the analysis process. Forex technical analysts usually look for patterns and levels of support and resistance on exchange rate charts. They also usually calculate technical indicators from market observables which can give them objective trading signals.
Those who use fundamental forex analysis generally look at how economic and geopolitical factors can affect national currencies. While the forex market can and does from time to time focus on different economic indicators, these major fundamental indicators tend to affect the relative values of currencies the most:
- Jobs data
- Central bank monetary policy and benchmark interest rate
- Inflation data
- The trade balance
- Gross Domestic Product (GDP) Growth
- Commodity prices
Of all the forex analysis methods, sentiment analysis is the least used by traders. This factor stems in part from the fact that the forex market is so decentralized that there is no single sentiment indicator that includes all market participants.
Some forex traders may use the Commitments of Traders (COT) report that the Commodity Futures Trading Commission (CFTC) issues to show currency futures positioning, and therefore market sentiment, on the Chicago Mercantile Exchange (CME). Some retail forex brokers also offer sentiment data by showing an anonymous aggregate of their clients’ long or short positioning.
However, these sentiment indicators only reflect the attitudes of traders in a very small percentage of the huge forex market, which is why so few currency analysts use them.
How to Apply Forex Market Analysis
Below are some tips on how to apply forex market analysis that forex traders can keep in mind when trading a currency pair.
Understand market drivers
The foreign exchange market is largely driven by capital flows between countries. These flows can be linked to international trade in goods and services, commodity prices and investment opportunities. Understanding the underlying factors that drive the currency market is an important part of the successful application of forex market analysis.
Chart of currency indices
Each national currency is exchanged against all other national currencies on the foreign exchange market. You can create and plot an index for a currency to illustrate its overall performance against a basket of other currencies for a given period. Examining this index and its evolution over time can give you useful insight into the underlying trends of a particular currency. US dollar and euro index futures are traded on the Chicago Mercantile Exchange (CME).
Seek consensus across multiple markets
You can sometimes tell if a currency pair is reaching a turning point in its exchange rate path by looking at the charts of other assets over the same time frame to see if a similar reversal has already happened or is currently underway.
Choose and time your transactions wisely
You have a better chance of trading successfully in forex if you can first identify major turning points in the long-term market and then refine your entry point using technical analysis. Additionally, having the patience to wait for good trades and the discipline to stick to your trading plan will generally benefit you over less prepared traders.
Using fundamentals to identify economic trends
Forex traders often use fundamental economic indicators to identify the causes of market movements and to gauge the long-term prospects of a currency pair. For example, they can analyze a country’s GDP, interest and inflation rates, and job and housing markets to gain insight into the strength of that country’s economy and therefore its change.
Forex Trading Strategies
Most successful forex traders operate with a plan that they have strategically developed in advance. This strategy helps eliminate the emotional element of trading that can interfere with a trader’s profitability. Such a plan will typically include one or more forex strategies that outline how the trader will enter and exit positions in one or more currency pairs.
These days, some forex traders may opt to allow technology to aid their trading endeavors by using fully automated forex trading robots that have a complete trading strategy coded into them.
Frequently Asked Questions
What is the most effective forex indicator?
The most effective forex indicator may depend on market conditions. That said, many forex traders use moving averages to identify trends and the relative strength index to indicate upcoming market reversals.
Does technical analysis work in forex?
Yes, technical analysis works in forex, and it’s generally the preferred method of market analysis used to time trades among experienced forex traders.
Do professional traders use indicators?
Yes, some professional forex traders use both technical and fundamental indicators, although they can operate in different ways.