Why you should analyze price movements to trade forex successfully
What you are about to read applies not only to forex trading where currencies are bought and sold but also to many other financial markets such as stocks, commodities and derivatives. Price movements create the conditions and the opportunities for profits (and losses!) and an astute trader will try and stay on top of the market by predicting which way prices are going to move. These price expectations will determine which currencies he is going to buy or sell and the timing of the purchase or the sale. Unfortunately, this is easier said than done because of the sheer complexity of the factors that determine currency price movements.
Price MovementIt is equally simplistic to say that the prices of currencies are determined by the relative supply and demand. It is true that demand for a currency will drive up its price and oversupply will drive down the price but it is exceedingly difficult to predict just when this will happen. Besides, the market is so volatile that it can move between the two extremes at mind blowing speeds. Don’t let all this put you off. Even as a beginner, you need to have an understanding of what fundamentally moves the market. There’s plenty of expert advice available but you have to be able to evaluate this advice to decide what is reliable. There are basically two techniques that are used in predicting price movements:
Fundamental analysis: fundamental analysis concentrates on the basic economic and political factors such as interest rates, economic growth and money supply that drive demand and supply for a particular currency. All these factors are studied and then used to predict future currency movements. The problem with fundamental analysis is that it requires a huge amount of data to be processed and this is complicated by disagreements as to which particular factors are important and the weightage they should be given. Generally speaking, there is agreement that interest rates and balance of payments are critical.
Technical analysis: technical analysis concerns itself solely with price movements and the direction of future price movements based on historical data. The main beliefs that underlie technical analysis are:
- -price itself is everything and all the relevant factors, economic or political, as well as market sentiment are incorporated in the price.
- -history repeats itself and prices tend to move in well marked patterns which can be identified on the basis of historic data
- -the use of charts and graphs enable analysts to spot these patterns and hence the future direction of prices. The process is commonly known as charting.
The two methods are often seen as complete opposites and their devotees are equally fanatical about the rightness of their methods. The best forex brokers will advise that you understand the basics of both because it is possible to use a combination of the two methods to your advantage. For instance, fundamental traders will often use technical analysis for timing their deals (to see how much the market is overbought or oversold). On the other hand, technical traders are known to use fundamental analysis to validate the predictions that they make by using their charts.
