There are three basic types of forex market analysis:
1. Technical Analysis
2. Fundamental Analysis
3. Sentiment Analysis
1: Technical Analysis
The main evidence for using technical analysis is that, theoretically, all current market information is reflected in price. If price reflects all the information that is out there, then price action is all one would really need to make a trade. Now, have you ever heard the old adage, “History tends to repeat itself“?
Technical analysts look for similar patterns that have formed in the past, and will form trade ideas believing that price will act the same way that it did before.
As more and more forex traders look for certain price levels and chart patterns, the more likely that these patterns will manifest themselves in the markets. You should know though that technical analysis is VERY subjective.
2: Fundamental Analysis
You have to understand the reasons of why and how certain events like an increase in the unemployment rate affects a country’s economy and monetary policy which ultimately, affects the level of demand for its currency.The idea behind this type of analysis is that if a country’s current or future economic outlook is good, their currency should strengthen.
The better shape a country’s economy is, the more foreign businesses and investors will invest in that country. This results in the need to purchase that country’s currency to obtain those assets.
For example, let’s say that the U.S. dollar has been gaining strength because the U.S. economy is improving. As the economy gets better, raising interest rates may be needed to control growth and inflation. Higher interest rates make dollar-denominated financial assets more attractive. In order to get their hands on these lovely assets, traders and investors have to buy some greenbacks first. As a result, the value of the dollar will likely increase
3: Sentiment Analysis
This is why sentiment analysis is important. Each trader has his or her own opinion of why the market is acting the way it does and whether to trade in the same direction of the market or against it.
The market is just like Facebook – it’s a complex network made up of individuals who want to spam our news feeds.
Kidding aside, the market basically represents what all traders – you, Warren Buffet or Celine from the donut shop – feel about the market. Each trader’s thoughts and opinions, which are expressed through whatever position they take, helps form the overall sentiment of the market regardless of what information is out there.
The problem is that as retail traders, no matter how strongly you feel about a certain trade, you can’t move the forex markets in your favor. Even if you truly believe that the dollar is going to go up, but everyone else is bearish on it, there’s nothing much you can do about it (unless you’re one of the GSs – George Soros or Goldman Sachs!).