Chances are, if you're just getting started analyzing currencies, you have a long list of questions: What is currency analysis? What are the different ways to analyze Forex assets? And how will my analysis inform my trading efforts? These are important questions to answer, and it's probably best to start with a quick definition of currency analysis.
In the simplest terms, currency analysis is the research of economic factors that affect exchange rates, as well as researching historical market data. Essentially, a day trader's goal is to extrapolate the future movement of a particular currency by analyzing market factors and economic data. This will help a day trader make better guesses as to whether a currency pair will lose or gain value.
Fundamental Currency Analysis
There are many different macroeconomic factors that can affect the value of a currency and its exchange rate. Fundamental analysis looks at these factors to determine the overall well-being of a country's economy, because economic standing is a strong determinant of currency value. Some factors a fundamental analysis might consider include:
- Inflation rates
And job growth
In effect, the goal is to get a gauge of the overall economic factors that may affect that country's currency. For example, a country with an increasing inflation rate may experience a decrease in currency value. A Forex trader might then enter a trading position betting on the downward trend of that currency. It's important to note, though, that it's difficult to trade on fundamental analysis alone. Most frequently, a trader will also need to conduct technical analysis.
Technical Currency Analysis
With the advances in technology, day traders have access to a wealth of Foreign Exchange market data. Technical analysis is the process of digging into this data to reveal market behaviors and price patterns. This analysis can be carried out over long periods of time - say a year or more - or in short, 4-hour time periods.
Forex trading software can be a useful tool for improving the insights yielded by technical analysis. For example, many Forex trading applications today are designed with advanced algorithms that measure these behaviors and price patterns in real-time, effectively automating the process of picking trades. One advantage of this type of analysis is that day traders have better knowledge of when to enter and exit a particular position.
Fundamental vs. Technical Analysis: Which is Better?
Ask any day trader what they prefer, and they'll likely say they use a combination of both. When used together, fundamental and technical analysis yield greater insights into the market, as another layer of data is added into the equation.
We can break it down further. For example, let's say a country just elected a politician who wants to enact a quantitative easing program. This program has the potential to weaken the value of the currency - that's a valuable piece of fundamental analysis. Combining this data with a technical analysis of that country's currency - long-term and short-term trends - will help you best determine the positions that will be most beneficial to you.