The Best Ways to Analyze the Forex Market

Types of Forex Market Analysis

Analysis can seem like an ambiguous concept to a new forex trader. But it actually falls into three basic types.

Fundamental Analysis

Fundamental analysis is often used to analyze changes in the forex market by monitoring figures, such as interest rates, unemployment rates, gross domestic product (GDP), and other types of economic data that come out of countries. For example, a trader conducting a fundamental analysis of the EUR/USD currency pair would find information on the interest rates in the Eurozone more useful than those in the U.S. Those traders would also want to be on top of any significant news releases coming out of each Eurozone country to gauge the relation to the health of their economies.

Technical Analysis

The technical analysis comes in the form of both manual and automated systems. A manual system typically means a trader is analyzing technical indicators and interpreting that data into a buy or sell decision. An automated trading analysis means that the trader is "teaching" the software to look for certain signals and interpret them into executing buy or sell decisions. Where automated analysis could have an advantage over its manual counterpart is that it is intended to take the behavioral economics out of trading decisions. Forex systems use past price movements to determine where a given currency may be headed.

Weekend Analysis

There are two basic reasons for doing a weekend analysis. The first reason is that you want to establish a "big picture" view of a particular market in which you are interested. Since the markets are closed and not in dynamic flux over the weekend, you don't need to react to situations as they are unfolding, but can survey the landscape, so to speak.

Secondly, the weekend analysis will help you to set up your trading plans for the coming week, and establish the necessary mindset. A weekend analysis is akin to an architect preparing a blueprint to construct a building to ensure a smoother execution. Tempted to trade without a plan? Bad idea: Shooting from the hip can leave a hole in your pocket.

Applying Forex Market Analysis

It's important to think critically about the tenets of forex market analysis. Here is a four-step outline.

Understand the Drivers

The art of successful trading is partly due to an understanding of the current relationships between markets and the reasons that these relationships exist. It is important to get a sense of causation, remembering that these relationships can and do change over time.

For example, a stock market recovery could be explained by investors who are anticipating an economic recovery. These investors believe that companies will have improved earnings and, therefore, greater valuations in the future—and so it is a good time to buy. However, speculation, based on a flood of liquidity, could be fueling momentum and good old greed is pushing prices higher until larger players are on board so that the selling can begin.

Therefore the first questions to ask are: Why are these things happening? What are the drivers behind the market actions?