Types Of Analyses
Technical Analysis refers to a chart-based model for analyzing and forecasting the future value of financial markets. It can be applied to stocks, commodities, or forex, and is usually based on a series of previous price movements. Just as any other forecasting, technical analysis is only a prediction and does not provide exact price levels for the future. It is more of a 'likely' outcome than a 'certain' outcome over the foreseeable future and is done by a wide range of charts that reflect price movements over time.
The very well known Charles Dow, who co-founded the Dow Jones & Company laid the foundations for the modern technical analysis. Of the various theorems put forward by him, the three most prominent are:
Price Discounts Everything
Price Movements Are Not Random
“What is,” is more important than “Why”
Price Discounts Everything
This theorem represents strong and semi-strong forms of market efficiencies. According to technical analysts, the current price of any asset or currency reflects all information available; hence, the current price is representative of the fair value and should, therefore, form the base for any analysis. The market price is after all affected by the accumulated information from the sentiment of investors, hedge funds, banks, traders, portfolio managers, buy-side analysts, sell-side analysts, market strategists, technical analysts, fundamental analysts, insiders, virtually all market players. So the idea with technical analysis is that the price of an asset carries enough information for people to trade.
Prices Movements are not Random
Although market participants agree that prices and the mood of investors tend to be random, they also exhibit some patterns, such as markets will trend in one direction or be trapped in a price range. Traders will also buy at levels they have bought in the past, and sell at prices where they have sold in the past, these levels will be clearly visible on the chart and could be used to formulate new trades.
“What is,” is more important than “Why”
Because the price of a currency will discount everything, the idea of TA traders is that it is not necessary for the technical analysts to know exactly why the price is rising or declining. What is important is “what is happening” e.g., the market is trending or trading sideways, instead of why it is happening.
Fundamental analysis is a more conventional way of trading markets and trying to predict the future of prices. It represents a view on the impact from global economic events that could affect financial markets. Those include major economic data releases, political news, company earnings, central bank policy meetings or any major announcements by influential organizations such as the IMF, the World Bank, to name a few.
The idea behind the fundamental analysis of any market is that if a country or company is economically performing well, the respective domestic currency or shares should strengthen and vice versa. This is because the economic health of any country or company determines the flow of foreign investment (FDI) and businesses, which means foreigners must buy a country’s currency to invest or start a business there.
Say for example, that the Eurozone's economy is doing well, the Euro (EUR) will be strengthening because of higher demand in the market, relative to other currencies. In response to robust growth as well as high inflation, the central bank typically hikes its key interest rate to curtail inflation and cool growth down. Higher interest rates tend to attract foreign traders and investors, and as a result, they buy the Euro (EUR) to make use of the relatively higher interest rates in the Eurozone.
Major economic events in Forex
We will now cover some of the most important economic events that drive Forex price movements. These are commonly used concepts that are key and need to be known by Forex traders.
Gross Domestic Product (GDP)
The GDP is one of the most important indicators that measure the economic performance of a country. It is in fact, the default measure of any country’s state of the economy. The U.S. GDP report is published at 8:30 am EST on the last day of each quarter, and it reflects the prior quarter’s economic activity. By definition, it is the aggregate monetary value of all the goods and services produced within the domestic economy during the quarter being reported. The growth rate of GDP is what traders watch, as they use it to compare one country against another.
It is the measure of the difference between a country’s exports and imports of tangible goods and services. If any country such as Japan or the U.S. exports more goods than it imports, the impact on its currency is positive and vice versa.
Higher exports than imports indicate a trade surplus, whilst higher imports than exports indicate a trade deficit.
Consumer Price Index (CPI), Inflation
This is the change in the cost of a bundle of consumer goods and services on a monthly basis and is the most widely used and trusted source of measuring a country’s inflationary trends. The U.S. inflation report is published at 8:30 AM EST around the 15th of each month. The number shows how much inflation has risen over a month and a year. Inflation reports are important for a currency as inflation is something that central banks try to control by manipulating interest rates and the supply of money.
Employment Indicators, e.g., U.S. Non-Farm Payrolls (NFPs)
These include all data related to the labor market with the unemployment rate being the most important metric to determine the economic health of a country and future inflation pressure. In the same report, traders, watch the number of new jobs created, and labor market inflation indicators such as “U.S. average hourly earnings”, or wage growth.
Forex markets are primarily driven by interest rates differentials between countries and central banks are therefore closely watched by all market participants. As an example, if the interest rate at bank A is at 10%, and the interest rate bank B is at 5%, then it is likely that traders will prefer to deposit their money with bank A over bank B if it is just the interest rates that set the banks apart. The same logic applies in Forex trading; traders will invest in high yielding currencies by borrowing in low yielding currencies, this sort of trading strategy is called the Carry Trade.
Simply put, market sentiment is the sentiment or speculation positioning that investors have while being positioned in the relevant market.
History shows that when the market is trending, retail traders tend to position against the trend. This means that if the trend is pointing upwards, retail traders try to be net-short the market. While, if the market is trending downwards, traders tend to be net-long. The sentiment indicator is thus, a useful tool to validate trends and breakouts in the market.
On the other end, when the market is range bound, retail traders tend to get it right. This means that if the market is range bound and the price is hovering near a major resistance level, and traders turn net-short, then this tends to point towards a decline in the value of the pair or asset.