THREE TYPES OF ANALYSIS
Several methods are available for analyzing the forex market with the intention of identifying profitable trading opportunities. In order to get profit you have to analyze the chart and besides that you have to keep your eyes on the news. And most importantly you have to control your sentiment. Combining the different approaches has been proved to be more beneficial in generating profits.
The three main types of analysis are:
Some traders prefer to concentrate on a single type of analysis because it makes it easier to master thoroughly one section of the forex market. However, taking a combined approach eliminates many of the weaknesses of concentrating on one method and increases the chances of identifying profitable trades.
Truth be told, to perform a comprehensive market analysis, you need all the three approaches. Just like a three-legged stool requires all three legs to be stable, forex trading also needs all the three types of analysis to be profitable.
If you focus only on one technique and ignore the others, your analysis could be weak and may lead to losses. A weakness of one technique of analysis can easily be surmounted by considering another type of analysis.
So, how do you combine the three types of forex analysis?
Let’s start by talking about each of the different approaches.
This type of analysis focuses on the various economic factors that affect the value of currencies. Some of the economic fundamentals include inflation rates, interest rates, political issues, unemployment rate, and Gross Domestic Product.
Traders using fundamental analysis to identify trade opportunities, called fundamentalists, believe that the underlying macroeconomic condition is reflected in the value of the currency.
As such, a country with a strong economy will have a stronger currency than a country with a weaker economy. Fundamentalists usually analyze a country’s economic outlook and determine whether its currency will appreciate or depreciate.
These traders often look at major economic announcements and reports to assist them in gauging the value of the associated currency. The important economic events are usually reported in economic calendars.
Before an economic announcement is released, leading economists from around the world usually come up with a consensus designating the extent of expectation for that report. Consequently, the upcoming economic report will be weighed against the consensus to determine its level of impact on the forex market.
The release of the report is often categorized as follows:
1.As expected—the released statement was according to the expectations.
2.Better-than-expected—the released statement was better than the expectations.(good for currency)
3.Worse-than-expected—the released statement was worse than the expectations.(bad for currency)
The interpretation of whether the announced report is above or below the consensus level usually leads to increased volatility in the market, as traders swiftly open and close positions. Often, broader degrees of variation between the consensus and the actual released report lead to extensive movements in the forex market.
If an economic report is better-than-expected, it indicates the economic outlook of the country is positive, which could lead to the the associated currency gaining value relative other currencies.
Conversely, if a report is worse-than-expected, it signifies the economic outlook of the country is negative, which could cause the associated currency to depreciate.
Most fundamental traders believe that a report at or nearly at consensus level will usually just result in a neutral effect.
This type of analysis involves assessing the past market behavior with the objective of projecting the future direction of currency prices. Followers of technical analysis rely on different systems and concepts to assist them in understanding the historical market happenings and identifying trading opportunities.
Some of the techniques and tools used for carrying out technical analysis include candlestick chart patterns, support and resistance levels, trend-lines, and indicators such as moving averages and Fibonacci.
Technical analysts believe in three essential assumptions. First, they regard the superiority of price action highly. These traders hold that all the fundamental factors that could affect the value of currency prices are already demonstrated in the movements seen on the market. Thus, technical analysts only concentrate on the price action visualized on the charts and do not spend time analyzing the causes of the movements.
Second, technical analysts emphasize that the movements of currency prices follow trends. The three main types of trends are an upwards trend (price is increasing), a downwards trend (price is decreasing), and a sideways trend (price is fluctuating without moving in any definite direction).
After a trend has started, technical analysts believe that price action will usually obey it before establishing a different trend. As such, the typical technical analyst places trades only in the direction of the prevailing market trend. This is the basis of the “Trend is your friend” phrase, which is common among traders.
The last assumption is that history tends to repeat itself. Technical analysts assert that market movements form patterns which are likely to reoccur in the future. Since these movements are orderly, systematic, and predictable, they enable traders to forecast the direction of currency prices with some degree of accuracy.
This is the third type of analysis. It involves analyzing the predominant feeling or attitude the participants have about the market.
Every market participant has his or her feelings regarding the behavior of currency prices. It is these thoughts and views that determine the decisions they make—whether to enter long or short trades.
Eventually, the prevailing direction of currency prices will reflect the combination of all the feelings and preferences of traders. For example, if the EUR/USD is trending upwards, it implies that most traders have a bullish sentiment on the currency pair.
Since most of us are retail traders, it’s not easy to cause the market to move in our preferred directions. If you believe that the British pound is appreciating, but everyone else is bearish on the currency, you cannot do much about it, unless you have enough money to trade huge volumes of currencies in the forex market.
Therefore, you need to carry out sentiment analysis to assist you in determining how to beat the big players at their own game.
You should analyze whether the market is bullish or bearish and then incorporate that into your trading strategy. With sentiment analysis, you can assess what most traders are thinking about a currency pair and use the information to make trade decisions.
A common technique of trading using sentiment analysis involves entering trades that are against the current market feeling. Thus, sentiment analysts often do not obey the common rule of trading: place trades according to the prevailing market trend.
If the market is moving strongly in one direction, sentiment analysts believe that a level of saturation has likely been reached—and thus a price reversal is about to happen.
For example, if a currency pair has been trending upwards (bullish sentiment), they will consider it to be overbought and will place sell orders in anticipation of the imminent shift in direction.
Some of the indicators you can use for gauging the market sentiment include the Commitment of Traders (COT) report, which is released by the Commodity Futures Trading Commission (CFTC), and the Relative Strength Index (RSI), which shows overbought and oversold market conditions.
Using fundamental analysis, technical analysis, and sentiment analysis together is pivotal for achieving forex trading success. Since every type of analysis has its own perks and pitfalls, concentrating on only one method is a recipe for disaster.
If you mix different techniques from the three types of analysis, you will enjoy the best of them all. With the combined approach, you’ll add weight to trade decisions and can become a more successful trader.
So, stop embracing a solitary approach of using only one type of analysis. Use different types of analysis together and the positive results will be reflected by the size of your trading account.
Here we, PRICE ACTION FOREX are trying continuously to combine these three types of analysis to give you signals and help you to gain a lot. So we think you’ll give us that opportunity to serve you guys.
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