Fundamental and Technical Forex Analysis
Fundamental analysis is a method of evaluating a security in an attempt to measure its intrinsic value, by examining related economic, financial and other qualitative and quantitative factors.
Technical analysis and fundamental analysis are very different. Unlike fundamental analysis, technical analysis actually ignores the fundamental factors, such as economic conditions and news, and is only applied to the price action of the market. Technical analysis for Forex mostly consists of a variety of Forex technical studies. Each of these studies can be interpreted to generate buy and sell signals or to help predict market direction.
Fundamental analysis is built from the basic idea that the value of a currency is determined by comparing the strength and weakness of a country’s economy to that of its trading partners. The stronger the country’s economy (which is measured by higher interest rates, lower inflation, greater productivity, stronger political stability, higher GDP growth and much more), the stronger its currency. In time, these fundamental factors create the long-term price trends that are typical of the currency markets.
In performing fundamental analysis, several economic factors are monitored and assessed. These factors are judged on the effect that they have on the country’s economic growth and development. These trends are generally quite complicated and are often large. They can be enacted over a long period of time. The political system is another factor which can affect the economic status of a country. The balance between the individual competition and the social welfare, or how open an economy is to foreign trade and capital, can have a great impact on the economy. The natural resources, such as mineral deposits or oil play a part, as well as the cultural and social makeup of a country, such as entrepreneurship, labor mobility and productivity.
Fundamental analysis uses economic statistics to view the economy and its currency. Rather that looking at the economy as a whole, these statistics often reflect a particular sector of the economy. This means that different statistics may actually point in opposite directions. For example, one portion of the economy may be growing steadily while another portion is faltering, or one industry is rising in importance while another is declining. Most statistics are also retrograde, showing you what has already happened but not necessarily what is going to happen in the future.
Local and world events (political, military, human and even natural events) can create large, fast and long-lasting repercussions in our volatile and interconnected world. When painting the overall picture of an economy (strengths, weaknesses, vulnerabilities, future potential and future course of its currency), a fundamental analyst must take all of this information into consideration. The fundamental analyst also uses personal experience and judgment to complete the currency analysis.
Transactions in the Forex market are different from those in a retail environment. When you make a purchase from a retailer, the price you pay for the product is predetermined by the seller. As a purchaser, you measure your need for the item against the asking price. Using this information, you decide whether to buy or not. In a Forex market transaction, the buyer and seller are both adjusting their price expectations continually, based on the information streaming out from the market to the participants and into the market from outside sources. A seller who is expecting the price to be higher in the near future may choose to withdraw an offer in hopes of getting a higher rate. If enough sellers withdraw their offers at a specific level, the deal price will rise to the next available offer. Likewise, if traders believe the price may fall, they may lower their own offers until they find a buyer, in turn driving the market price down.
As the market participants react to the changing information, the combined reaction causes movement in price. An observer sees the “market” as having traded lower because the thousands of individual decisions that make up the movement are viewed as one large mass decision. We often say “the market took profit today” or “the market reacted badly to the news”. The “market” is a picture of the thoughts of its participants, in other words, a snapshot of our minds.
Market movement is produced by the difference between what the participants assume will happen and what actually happens in the market. When an economic statement is released and it is the same or similar to the general opinion of what would happen, the trading reaction is often muted. The statistic is said to be “priced into the market”, meaning that several prior trading decisions assumed the state of the economy displayed by the statistic, which was reflected in the trading rate. On the other hand, if the statement is different than what the participants assumed, then most of those trading decisions will be immediately unwound, resulting in price movements that reflect those changes. It is the tension between the opinion of the majority of the participants as reflected in the trading rate and the economic, statistical or rate reality that dominates currency trading.
Economic Indicators 101
An economic indicator is information amassed and published by a government or private entity recording the activity in a particular economic sector, either in a specific industry or in an entire economy. Most indicators are statistical, but they can be anecdotal or subjective as well. Indicators are recorded and published on a regular basis by many organizations and are used by traders to assess the strengths or weaknesses of an economy, to predict future activity, to judge central bank policy, and to provide insight into the many economic variables that make up a modern industrial economy.
Information accumulated and broadcast by a government or private entity recording the activity in a particular economic sector (either in the entire economy or in a specify industry) is an economic indicator. Most indicators are statistical, but that can also be subjective or anecdotal as well. Several different organizations register and broadcast economic indicators on a regular basis. They are used by traders to determine the strengths and weaknesses of an economy, to judge central bank policy, to predict future activity and to provide insight to the many economic variables that establish a modern industrial economy.
Most indicators are classified as either leading or lagging. If the indicators track economic factors that often change before the general economy, they are leading indicators. These indicators are generally used to predict future economic conditions. On the other hand, lagging indicators record activity that has already occurred and may or may not prove useful in prediction.
Economy-wide indicators are the broadest measures of productive activity and record the result for an entire economy. Usually collected by governments, they are among the most authoritative statistics.
The broadest measure of productive activity are economy-wide indicators. These indicators record the result for an entire economy, rather than that of a specific sector or industry. Economy-wide indicators are usually collected by governments and are among the most authoritative statistics.
Examples or economy-wide indicators are:
- Gross Domestic Product (GDP)
- Consumer Price Index (CPI)
- Producer Price Index (PPI)
- Unemployment Rate
Industry and sector based statistics normally pertain to a particular industry, such as housing or a particular economic activity, such as retail sales. Collected by both government agencies and private sector groups, the activity they track is more limited, and can have a close correlation to the broader indices, generating considerable trading interest.
Statistics that generally pertain to a particular sector, activity or industry, such as retail sales or housing, are
industry and sector based statistics. These statistics are collected by both private sector groups and government agencies. The activity that is tracked by these statistics is more limited and can have a close relationship to the broader indices, which generates a considerable trading interest.
Examples or industry and sector based statistics are:
- Durable Goods Orders
- Housing Starts
- Building Permits
- New Home Sales
- Retail Saless
- Purchasing Managers Index
- Institute for Supply Management (ISM) Survey
Finally, the indicators that gauge business and consumer opinions on current economic conditions and their expectations and intentions for the future are called sentiment indicators.
Not all statistics on a single topic are of equal importance. Some government and central banks prefer one measure to another and the markets will assign that much more trading weight to the favored statistic. Other statistics gain or lose interest over time depending on their volatility, changes in the economy or newer and better measurement techniques.
Statistics on single topics vary in importance. Some central banks and governments prefer one measure to another. Based on that preference, the markets will assign the greater trading weight to the favored statistic. Depending on their volatility, changes in the economy or newer and better measurement techniques, other statistics will gain or lose interest over time.
Depending on what is believed to be more relevant to the current market and economic conditions, traders will also focus on other statistics. For example, economy-wide statistics will be prevalent when the market focus is on GDP growth. In contrast, industry-wide statistics will be the focus of interest when developments in that industry are of concern.
Technical analysis is probably the most commonly utilized means of decision making and analysis in the foreign exchange market. Here, we cover the basic concepts of technical analysis by way of Forex charting.
SUPPORT AND RESISTANCE
The points where a chart experiences recurring upward or downward pressure are known as support and resistance levels. The support levels exist at the lows and the resistance levels exist at the highs. When the levels are broken, the generally become the opposite. An example of this would be a support level breaking to the downside. It would often become a new resistance level. In a market that is on the rise, a broken resistance level could become support for the upward trend. Likewise, a support level that is broken in a market that is on the decline could become a new resistance level for the downward trend.
TREND LINES AND CHANNELS
If you are looking for simple yet helpful tools to confirm the direction of market trends, you could turn to the trend lines. To draw an upward straight line, you would connect at least two successful lows (however, you would preferably connect more). It is necessary that each successive point on the line be higher than the previous point. The line’s continuation helps to determine the path that the market will move along. An upward trend is a solid way to find support lines and levels. To chart the downward lines you would also connect two or more points. The validity of a trend line is, in part, related to the number of points that are connected.
To identify the overall trend, moving averages can be very helpful. The moving averages show the average price of a currency at a specific point over a specific period of time. Because they reflect the latest average while still adhering to the same time measure, they are called “moving”.
Moving averages are not perfect. Because they lag the market, they don’t necessarily alert the trader to a change in the trends at the best time. To counteract this issue, it is best to use a short period of time when using moving averages. This makes it more reflective of the recent price action than it would be if you use a longer period. However, the moving averages of short periods are subject to more false trend-change alerts.
As an alternate, the trader can use the moving averages by combining two averages of different periods. When the shorter-term average crosses over the longer-term average, buy signals are usually detected. Likewise, sell signals are detected when the shorter-term average falls below the longer-term average.
Mathematically distinct moving averages have three main types: 1) Simple Moving Average (SMA), 2) Exponential Moving Average (EMA) and 3) Weighted Moving Average (WMA). The EMAs and the WMAs give greater importance to the most recent price data. SMAs give equal importance to all of the data in the period. Because of these differences, many traders prefer EMAs and WMAs over the SMAs to help counteract the lag in moving average alerts.
INDICATORS AND OSCILLATORS
Indicators and oscillators vary greatly in both their derivation and their usage. The indicators, which can be found right on the candles or price bars, include moving averages, Parabolic SAR, Bollinger Bands and much more. These indicators are usually lagging, providing a historical view of the price action. The indicators can often confirm or provide clues as to the direction of present momentum and past trends.
On the other hand, the oscillators are generally shown separately above or below the price bars. Like the indicators, the oscillators are also lagging. The oscillators are good at revealing oversold and overbought conditions. Because of this, the oscillators are most useful for traders who would like to identify ranging circumstances, rather than trending circumstances. The oscillators include RSI, Stochastics, MACD and more.
Other technical drawing tools are, like analysis tools, popular and also varied. Chart drawing tools many adherents, with several different versions of Fibonacci formations, Andrew’s Pitchfork, the Gann Fan and much more. Many of these analyses are used to reveal areas of importance, such as the support and resistance levels. The most basic drawing tools are the trend lines, regardless of whether they are diagonal or horizontal. Beyond the trend lines, the drawing tools become increasingly complex and are often created from complex mathematical foundations.