Explaining The 3 Major Types of Forex Analysis- Technical, Fundamental and Sentiment
The forex market is not easily navigable if you do not understand the major types of forex analysis. We will go through technical analysis, fundamental analysis and sentiment analysis. By the end of it, you will have a good understanding of how analysis works. If you are new to the forex market, you can check out the best forex brokers in our forex broker reviews.
The forex market is one of the largest in the world. It has many variables that any forex analysis needs to take into account. Over the years, we have developed ways of looking at the market and categorized them into three main components that have an overarching and complete look at what moves the forex market.
- Technical analysis
- Fundamental analysis
- Sentiment analysis
The best forex brokers in the world provide you with the tools to do all the forex analysis you need. As a trader, you will need to look at the forex broker reviews we have to get the best tools to help you survive the forex market.
Forex analysis helps you determine whether to buy, sell, or wait on trading. No one is exempt from the use of forex analysis to look at the forex market. Investment managers, hedge funds, banks, and companies invested in the market; all use forex analysis to try and stay ahead of everything.
As you will find out in the following brief insights into the main methods, there is a lot you can learn from them. Let’s get started on technical analysis first.
Forex Analysis- Technical Analysis
In technical analysis, we study the historical price action to get the patterns that will show us the likelihood of future price movement, going in a specific direction. In forex analysis, technical analysis is mostly about the fact that history tends to repeat itself in similar ways.
As the forex market experts will tell you, it all comes down to two things, when you are using technical analysis:
- Identify a trend
- Identify the support/resistance through the use of price charts or timeframes
The forex market tends to do these three things:
- It moves up
- It moves down
- It moves sideways
The prices you will see when using technical analysis usually moves in a zigzag manner, and the result is that the price action exists in two states: range and trend. Range refers to when the price zigzags sideways. The trend is when the price zigzags higher (also called an uptrend or bull trend) and when it zigzags lower (also called a downtrend or bear trend.)
Pro Tip: When in the forex market, technical analysis is useful for helping you know when and where to enter a market and when and where to leave it.
Applying Technical analysis
When we talk of forex analysis and technical analysis, in particular, we are keenly aware of the fact that the markets operate chaotically. Not even the pros know what will happen next. However, the price action does not follow this pattern of chaos. There is a method to the madness.
According to Chaos Theory in mathematics, within any state of chaos, some patterns tend to repeat themselves.
The type of chaotic behavior that we see in things like the weather forecast has a pattern, and this is the same case for technical analysis.
So, what we learn here is:
- As a trader doing forex analysis, it is not about being right or wrong. That is why technical analysis is an excellent way to come up with the probabilities to make sure that you only enter the market when the odds seem to be most in your favor.
- You are determining the risk to reward ration based on your technical analysis
Any trader who is a professional will tell you that when it comes to forex, there is very little luck involved and no magic at all. There are no technical indicators that will miraculously point out some secret strategy.
We stress these points, but just so you do not forget, always make sure that you have:
- A good strategy for risk management
- Discipline as a trader
- An ability to control your emotions
Almost any person can guess right and win on a trade once in a long while but, if you do not follow what the technical analysis and forex analysis shows you, you will not be able to know where to move next.
Your risk assessment will suffer, and you will lose money. It is impossible to be profitable in the long run, if you do not have a good understanding of facets like technical analysis. Always look through our forex broker reviews to get the brokers who provide you with access to correct and real-time data.
To sum up, fundamental analysis, as is understood by most of the forex market, we look at what it does. With fundamental analysis, the aim is to quantify the current factors, which is also why it is called trading the news. The best forex brokers will give you access to tools that bring in the news that affect your trades.
We do fundamental analysis by predicting the future factors based on what affects/is affecting, the economy of the country whose currency is in a pair we trade. In the forex market, fundamentalists look at:
- The Gross Domestic Product of a country
- The inflation rates
- The interest rates
- Employment reports
- Balance of trade reports
- Disruptive geopolitical occurrences
There are more variables, but the one that affects fundamental analysis the most is interest rates. When making decisions, never overlook the interest rates. A higher interest rate means that a country has more investors who increase the value of a country's currency over time.
If the interest rates are set too high, they will mean that there will be inflation, which could be a problem because it takes away the value of a currency, the higher it goes. The forex markets may seem tricky, but with fundamental analysis, you could stay ahead of the curve.
To understand how you can trade the news better, let’s look at the approaches we use.
Pro Tip: The approaches used here, form their basis on how the forex market is affected by micro and macro-economic data, geo-politics, and the connections existing between them.
- Top-Down Analysis
In fundamental analysis, we analyze the broad macroeconomic factors and the data collected from them to narrow down the search. This kind of forex analysis aims to include only the currency pairs in which we have an interest and see a potential for profit.
- Bottom-Up Analysis
This approach of fundamental analysis is the opposite of the first. It works when you do a forex analysis of the currency pair and work upward to get the aggregate macroeconomic data behind price action.
- Interest Rates and Balance of Trade
We attribute these two as critical factors driving a country's currency. If a country has a surplus of trade, its goods and services are in high demand, meaning their currency is in high demand, which drives up its value. As we highlighted earlier, forex analysis shows that higher interest rates lead to more cash flow and subsequently drive up the currency value.
- Demand and Supply Forces
In valuing the commodities produces by a country, the laws of demand and supply, apply. For example, an international respiratory pandemic, will increase the demand for ventilators and face masks, which we use in combating such a thing. The fundamental analysis shows that the most prominent supplier's currency will rise in value.
In fundamental analysis, you are trading the news. You will need to be updated on all the things happening at any given time. Have notifications specific to the things that could affect your trade the most. The forex market can be easy to navigate when you get a handle on forex analysis, based on keeping tabs on the news.
Forex Analysis - Sentiment Analysis
Finally, we have sentiment analysis where we base findings and data on the number of people buying or selling a particular currency at any given time. This kind of forex analysis looks into the thought process of the forex market and is more about feelings than anything else.
As you will find out, even feelings can be quantified if you have a broad base of data to work with. Sentiment analysis will help you get the mood or tone of the forex market. It is also called crowd psychology.
As a trader, you will need to use sentiment analysis to look for exceptionally large amounts of investment in a particular currency, moving in a specific direction. It is the indicator that reveals what is happening underneath the perceived chaos of the forex market.
How Sentiment analysis Works
With this type of forex analysis, you will be looking at a large number of investors who are buying a given currency, for example. The number of future sellers of that currency will balloon. The number of available buyers shrinks.
With something like that, the forex market will have created a price reversal because all those buyers will eventually want to/have to sell.
Market sentiment is defined as either negative or positive. In sentiment analysis, this depends on the attitude that traders have towards a specific currency. Traders use sentiment analysis in describing the market as either bearish or bullish.
Sentiment indicators are the best way for forex analysis to happen, using this approach.
Let us look at an example to understand how the forex market works when it comes to sentiment analysis.
Back in 2016, when Britain voted to leave the EU, the GBP (Great British Pound), fell to its lowest point in almost 31 years. The sentiment from the market was negative. The next year in 2017, the sentiment analysis showed a positive attitude.
2018 brought negative sentiment again with the delay and a 'No-Deal Brexit' fiasco. All this happened, and then the prices started to trend upwards in 2019. All the things that happened were because of the events in Britain at the time and how the forex market felt about all of it.
Uncertainty brings negative sentiment to forex analysis, and certainty brings stability and a positive attitude.
Putting Sentiment analysis Indicators To Task
The indicators used in sentiment analysis are presented numerically or on graphs. They show how optimistic or pessimistic traders are about the forex market at any given time. The representations could show the percentage of trades that are in a particular position in a specific currency pair.
For example, 75% of traders going long and 25% going short, means that 75% of them are long on the currency pairs. Sentiment analysis is quite simple if you have the right tools. It is why you will need to pick the best forex broker to avail the data and analysis tools you need.
Informed decisions will ensure that you do not make mistakes. Make use of the tools provided and reliable software to make sure that you have everything you need. On that note, take a look at our forex broker reviews to make sure that you have accurate information regarding which ones offer the best services.
The Hybrid System’s Advantage
When trading, you need to look at all of this as more than just you making choices bases on any one of these styles. As with the forex broker reviews, we look at everything all at once and decide which system works best for you, but in this case, it is a matter of time and experience.
These analyses on their own can be illuminating and might shed some light on which direction to take. However, a combination of all of them is better than using just one. After you are comfortable using all of them independently, you can then integrate them and create your own system.
To Wrap Up
As you have seen in the explanations, the forex market has a lot going on at any given moment. Technical analysis shows you a future prediction based on past price movement. Fundamental analysis quantifies the current factors and predicts future factors affecting a given country's economy. Sentiment analysis forms its basis on how many people feel a certain way about a specific currency.
The big takeaway is that there is so much more to the forex world than most beginners imagine. As we have stressed throughout, you should choose the best forex broker review to make sure that you get the best forex broker with all the right tools to perform all these functions.
Forex analysis should be a big part of your education as a forex trader. Once you have mastered all these, you will be able to make the right call. To ensure that you employ brokers who look out for you, check out our forex broker reviews for the best tools.
Sentimental Market is used by the majority of forex traders to trade in one significant direction. The sentiment analysis helps the trader to understand the market and move accordingly. The traders have their own set of opinions related to the forex market. With their own opinion, they lead and trade in the forex market and helps the individual to take a proper decision considering the market and information available for initiating the trade.
Technical analysis is the study of trading activity through the use of patterns, trends, price movement, and volume. Fundamental analysis is the study of price movement to determine the value of an asset. Sentimental analysis is feeling the tone of the market through the study of crowd psychology.