Knowledge is power when trading forex. With a thorough knowledge of how forex trading works, you may as well rely on guesswork when making trades. This, as we all know, is akin to throwing money into slot machines.
No serious forex trader opens a position without conducting analysis. Analyzing the market is how you make the right decisions. Analysis isn’t fool-proof, but it reduced the risks. There are three main ways to analyze the markets with a view to working out a potentially profitable trading position. These include technical analysis, fundamental analysis, market sentiment.
Let’s look at each one individually.
Technical analysis means studying price movements. For example, if you are trading EUR/USD, you would look at price trends for each currency and use this information to help you make an informed decision about which way the currency might move. Traders often find it useful to look at historical trend lines, as they know that the same patterns are often repeated time and again.
Trading platforms such as MT4 on easyMarkets include technical analysis tools. Complex data is presented in the form of charts and graphs, which makes it easier to digest. You can see at a glance obvious patterns and trends, which should help you spot whether there are any trading opportunities.
Be aware that the information presented in technical analysis charts and graphs is subjective. Just because you can see a trend as clear as day, it doesn’t mean another trader will spot the same pattern.
When traders talk about fundamental analysis, it means they are looking at wider economic, political, and social trends. Conducting fundamental analysis means reading the financial news, checking an economic calendar, and paying close attention to what’s happening in the world.
In general, a country with a strong economy and stable political landscape will have a strong currency, but when times are tough, the exact opposite is true.
During periods of political upheaval, currencies tend to sink. For example, following the UK Brexit referendum result in 2016, the pound sank to an all-time low. It has since recovered, but GBP is still very volatile.
If all traders made the same trading decisions based on the same information provided by technical and fundamental analysis, each trade made on the forex market would be identical. But no two people think alike.
We all form our own opinions based on the data presented to us. Just because trader A decides the USD is about to tank following an inflammatory tweet from the White House, it doesn’t mean that trader B thinks the same.
It is a good idea to take market sentiment into account. You can trade against market sentiment but be aware that you might end up making a loss.
Which is the Best Type of Analysis?
Sensible forex traders use a combination of all three types of analysis. They know that sticking to one type of analysis is likely to leave them underinformed. Use technical tools, be well informed of what’s happening in the world, and pay attention to overall market sentiment. It’s the best way to manage risk.