There are two schools of thought in analyzing financial markets: Fundamental and Technical analysis. Technical analysis studies price movements while fundamental analysis studies underlying economic causes for price movements.
Fundamental Analysis
Fundamental analysis focuses on the underlying economic factors that move the FX market. Traders who use this method tend to be long term traders. Fundamental analysis is purely focused on economic, geo-political and social events that drive supply and demand. Supply and demand play the biggest roles in reflecting the currency price fluctuations.
From a fundamental perspective, the main factors that impact exchange rates are:
- Interest Rates
- Capital & Trade Flows
- Economic Conditions (Unemployment, Inflation, etc.)
Any news about interest rates may affect exchange rates. When the interest rate of a currency goes up, this currency sometimes becomes more attractive to investors who seek higher returns. More investments are placed in the country and hence the value of this currency in relation to other currencies increases in value.
Capital flows represent funds sent from one country to another. This determines the net amount of a currency bought or sold for a foreign investment. Positive capital flow means money coming into a certain country for investments exceeds the investments going out of a country. Negative flow indicates the opposite: more money is flowing out of the country for investments in foreign markets. Trade Flows measure the balance of trades (exports - imports).
Trade flows are the buying and selling of goods and services between countries. Net exporters run a trade surplus because they sell more goods to other countries than they buy. Net importers run a trade deficit since they buy more goods than they sell. A net exporting country usually has a higher demand or their currency because more people are buying their goods and hence need this currency to pay for these goods.
Technical Analysis
Technical analysis is based upon studying price movements using price patterns and/or statistical data. It has gained popularity over the past decade, especially with new innovations and developments in technology. This has allowed traders the ability to analyze movements and trends much faster using computers. Technical analysis offers insight into what forex traders are doing. Traders use charts to identify patters and trends to make successful forex trading decisions. Technical analysis can be used in different time frames. Whether it is monthly, daily, hourly, or even several minutes. A trader gets to choose the time frame that suits his fx trading style best. Three widely used concepts of technical analysis are:
Support can be defined as the "floor" through which the currency pair has difficulties falling below.
Resistance, on the other hand, is the opposite: the "ceiling" through which the currency pair has trouble breaking.
The reason why the price has trouble breaking these levels is the existence of actual orders around these levels. There is no formula to accurately calculate these levels, they are observed by watching the market and hence involve a subjective element.
Trends are simply the general direction that the currency pair is moving. It could be up, down or sideways. The length of the trend determines its strength. In an uptrend, there should be at least two low points on the chart with the second point higher than the first. In downtrends, there should be at least two high points with the second point lower than the first. Sideways trends have two upper points at the same price and two lower points also at the same level. A channel is formed when prices trend between a well defined trading range.
Examples:
1. Uptrend
2. Downtrend
3. Sideways
These are the levels at which the market is expected to retrace to after a trend. Fibonacci retracement key levels in most markets are: 38.2%, 50% and 61.8%. Suppose a currency pair is on an uptrend from 1.2000 to 1.3000, which is a 1000 pip rally. When the currency pair reaches 1.3000, how much will it retrace?
38.2%: The size of this movement is 1000 pips. 1000*.382 = 382 pips. So after rallying 1000 pips, we expect the currency pair to retrace 382 pips. Using similar calculations we find out that after a 1000 pip rallya currency pair would retrace 500 pips back at the 50% level and 618 pips back at the 61.8% level. Obviously, the 50% level is a more significant buying level than the 38.2% level and the 68.8% is the most significant.
Fibonacci
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