3 Types of Forex Analysis

February 27, 2019

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Forex analysis techniques talking points:

There are three general types of forex analysis traders use to anticipate market movements and analyse trends.
Traders tend to use one or a combination of FX analysis methods to fit their personality and/or trading style.
It can be useful to identify trades using the analytical approach in a forex practise account

There are several different ways to analyze the FX market in anticipation of trading. Although categories of analysis may be plentiful, traders should keep the analysis simple enough to identify good trading opportunities.

This article explores the three most common forex analysis techniques: Fundamental, technical and sentiment analysis, and how they help to shape a trading strategy. Thereafter, it is up to the individual trader to try find out what type of analysis suits there trading style.

The 3 Most Common Types of Forex Market Analysis:

1) Fundamental

Forex fundamentals center mostly around the currency’s interest rate. This is due to the fact that interest rates have a sizeable effect on the forex market. Other fundamental factors are included such as gross domestic product, inflation, manufacturing, economic growth activity. However, whether those other fundamental releases are good or bad is of less importance than how those releases affect that country’s interest rate.

Traders reviewing the fundamental releases should keep in mind how they might affect the future movement of interest rates. When investors are in a risk-seeking mode, money follows yield (currencies that offer a higher interest rate), and higher rates could mean more investment. When investors are in a risk adverse mentality, then money leaves yield for safe-haven currencies.

The DailyFX website offers a lot of assistance on identifying how a fundamental release could affect the value of the currency. Check out the economic calendar for events coming up this week.

2) Technical

Forex technical analysis involves looking at patterns in price history to determine the higher probability time and place to enter a trade and exit a trade. As a result, technical analysis in forex is one of the most widely used types of analysis.

Since FX is one of the largest and most liquid markets, the movements on a chart from the price action generally gives clues about hidden levels of supply and demand. Other patterned behavior such as which currencies are trending the strongest can be obtained by reviewing the price chart. An example of this can be seen below in the GBP/USD chart where the US dollar is strengthening against the Pound Sterling.

Other technical studies can be conducted through the use of indicators. Many traders prefer using indicators because the signals are easy to read, and it makes forex trading simpler.

Technical versus fundamental analysis in forex is a widely debated topic. There is no right answer to the question of which type of analysis is better and traders tend to adopt one, or a combination of the two, in their analysis.

3) Sentiment

Forex sentiment is another widely popular form of analysis. When you see sentiment overwhelmingly positioned to one direction, this means the vast majority of traders are already committed to that position.

Perhaps this can be better explained with an example. Let’s assume that an overwhelming number of traders and investors are bullish the Euro. They think the Euro is going higher. Since people vote with their trades, we can assess through DailyFX (which uses IG Client Sentiment) that the EUR/USD sentiment shows a majority of traders are buyers in the currency pair.

Since we know there is a large pool of traders who have already BOUGHT, then these buyers become a future supply of sellers. We know that because eventually, they are going to want to close out the trade. That makes the EUR to USD vulnerable to a sharp pull back if these buyers turn around and sell to close out there trades.

More astute traders will analyze retail sentiment alongside sentiment at the institutional level. Senior Analyst at DailyFX, Tyler Yell explains how traders can analyze the Commitment of Traders (CoT) report for clues on how the institutional market is positioned and how to implement this analysis into their trading analysis.

Learn more about sentiment trading through DailyFX to provide trading opportunities based on IGCS.

How to apply forex techniques to your trades

Traders can utilize a mix of all three types of forex market analysis. This can be done by:

Identifying long term trends with the use of fundamental analysis
Pin-pointing ideal entry points using technical analysis and accompanying indicators
Making use of client sentiment as the last check box before entering the trade.

Keep reading for in-depth examples of how to analyse forex market trends with the three analysis techniques:

1) Use fundamentals to assist in identifying a long-term trend:

Analyzing a country’s GDP, interest rate and inflation rate provides insight on the strength of that country’s economy and by extension, their currency. For example, if the US begins an interest rate hiking cycle, the US dollar will look attractive. If enough investors/traders buy US dollars this will prop up the value of the USD.

2) Apply sound technical analysis to spot entries into the market:

Using multiple time frame analysis and an indicator like the MACD or Relative Strength Index, traders can spot ideal entries into the market.

3) Consider client sentiment:

Traders can analyze client sentiment either by observing the net number of traders long or short, or by trading the difference in net short/long movements. The main takeaway however, is that retail clients tend to trade against prevailing trends therefore, making client sentiment a contrarian indicator.