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Two Methods For Analyzing Movements in the Forex Market

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Two Methods For Analyzing Movements in the Forex Market

In many ways the Forex, foreign exchange or foreign currency market, is no different from any other market and prices are driven largely by the simple laws of supply and demand. If a currency is in demand its price will rise, but if demand is low its price will fall. This principle is fairly simple to understand and you might think that, against this background, it should be quite easy to predict movements in currency prices. Unfortunately, this is not the case.

Up until the mid 1980s the majority of traders relied on a method known as fundamental analysis to predict movements in the market. Today however an increasing number of traders have turned away from fundamental analysis in favor of technical analysis, although there are still a significant number of traders who have stuck with fundamental analysis, or who use it to back up the results of their technical analysis. Let's take a brief look at each of these two analytical methods.

Fundamental Analysis

The principle behind fundamental analysis is that it is changes in political, economic and social factors which dictate supply and demand and movements in the market can be predicted by studying these factors. Fundamental analysis thus looks at political events and economic data such as inflation, interest rates and trade figures, as well as social data such as employment rates. Historical data is then used as the basis for predicting movements in the light of current figures. In other words an analysis of, for example, the effect that rising or falling interest rates have had on currency prices in the past is used to predict the effect that a rise or fall in rates today will have.

The greatest problem with fundamental analysis lies in the huge quantity of data which needs to be analyzed and in the fact that there is a wide degree of disagreement over which data is important and which is not. It is also felt in some quarters that since the world has changed dramatically in recent years many of the factors which may have affected currency prices in the past will not necessarily have the same effect today. Perhaps one area of general agreement however is that analysis of a country's balance of payments is crucial to the success of fundamental analysis. The balance of payments is important because it reflects the flow of currency in and out of a country and a situation in which money is flowing into a country faster than it is flowing out, or vice versa, will clearly affect currency prices. Analyzing just how prices will be affected is of course something which is hotly debated by fundamental analysts.

Technical Analysis

The principle behind technical analysis is simply that, while political, economic and social factors will indeed drive the market, it is not necessary to study, or even to understand, because these factors in whatever combination you choose have occurred time and again in the past and their affect can be seen by simply studying the historical pattern of currency movements.

Accordingly, the main tool of the technical analyst is the chart, or more accurately a series of charts, which provides a graphical representation of the market over time. A study of such charts will show that there are clear trends and patterns to price movements and so extending a current chart on the basis of past patterns will show the direction in which a currency will move. As with fundamental analysis, there is a wide range of different charting tools available and widespread disagreement over which are valuable and which are of lesser or little use.

Should You Choose Fundamental or Technical Analysis?

Deciding which method you should adopt is no easy matter, although most novice traders today choose to follow technical analysis. This could of course be because they firmly believe that this is the better of the two methods but, in the majority of cases, it is probably because learning the skills of fundamental analysis takes a great deal of time and involves a steep learning curve and because this is the direction in which Forex trading is moving.


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