Global currency trading takes place on the enormous and complicated foreign exchange market (forex). The market’s high level of volatility makes it a difficult environment for traders to operate in. Understanding market dynamics and the instruments available for market analysis is crucial for success in forex trading. Traders use tree different market analysis techniques to produce forecasts. These three concepts — technical analysis, fundamental analysis, and sentiment analysis — we will discuss in this article.
So, the three types of analysis that traders use most often are:
- Fundamental Analysis;
- Technical analysis;
- Sentiment analysis.
While some Forex traders regularly use one or the other, the most successful ones are able to combine different types of them.
Each Forex trader has his own personal qualities and trading style, but the most important thing in the markets is to have the necessary information.
Let’s take a more detailed look at each type of Forex market analysis:
1. Fundamental Forex Analysis
The first type of Forex market analysis is fundamental analysis.
Fundamental analysis gives traders the opportunity to look at a currency pair and analyze data on the economy of the country to which it belongs. Any economic, political or even social processes occurring in the economy affect the supply and demand of the national currency. If a country has a strong economy, then the demand for its currency from investors will be high, which will ultimately lead to an increase in its exchange rate.`
The most important piece of fundamental news for the Forex market is monetary policy and how the Central Bank’s decision to raise or lower interest rates will affect demand. Almost all the most important Forex market news found on the economic calendar will have an impact on monetary policy, and fundamental analysis will require you to take these into account.
Remember that fundamental analysis alone will never be the determining factor for short-term movements, so you should only view it from a broader market perspective.
2. Technical Forex Analysis
The second type of Forex market analysis is technical analysis.
Technical analysis is the art of searching for patterns on a price chart in order to predict future movements in the market.
Technical analysis comes down to finding entry and exit points for trades with the highest probability of success. At the end of the day, all price charts show us is human behavior. It is well-known that people are habitual creatures who will repeat their past behavior patterns, often in predictable ways.
This is where technical analysis allows us to find patterns on the chart that show us the potential levels at which traders will look for entries and exits from the market.
One of the disadvantages of using technical analysis in trading is the fact that it is a subjective form of analysis where two traders can come to opposite conclusions based on the same chart. It is in this situation that the use of technical indicators can help to partially eliminate this subjectivity, at least from a risk management perspective.
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3. Sentiment Forex Analysis
The third type of analysis is sentiment analysis.
Sentiment analysis in the Forex market allows traders to find out whether a given market is predominantly bearish or bullish.
If you can assess the balance of market forces in the rest of the market, then you know how to make decisions based on what they will be forced to do in the future.
Sentiment analysis is an often overlooked form of market analysis that, when properly combined with fundamental and technical analysis, can give you a real profit advantage.
Sentiment analysis is most often used by Forex traders who trade against the majority and want to take a position in the opposite direction of the overall market trend. The point is that if you know that a given market, for example, consists of 90% long positions, then the only way for traders to close these positions is to sell them. Supply and demand will force the price to go down as only one seller will remain in the market.
Combine three types of analysis into one
Forex traders will always have a preference for one type of analysis.
While the above sounds completely normal, and we encourage you to choose the view that suits your specific trading strategy, the most successful traders can still combine elements of all three types. Use fundamental analysis to examine the overall direction of an economic development for deviations from long-term trends. Support it with short-term technical analysis to determine market entry points with even greater accuracy. Lastly, gauge market sentiment to ensure you are not trapped by changing forces in the market.