In the world of investing, there is no shortage of investing strategies. Forex shares the same characteristics. It is up to you to decide which strategy fits your risk appetite and your style of trading. To assist you in this decision, I will highlight two of the most popular ways to analyze currencies; fundamental and technical analysis.
First, lets begin with fundamental analysis. When someone says they are a fundamentals-based investor, they are referring to hard data. For stocks these are financial statements but for forex and currency trading, fundamental data is the macro reports such as GDP, unemployment, payrolls, consumer confidence, etc. To be a successful fundamental investor in forex, you must be absolutely diligent on knowing when key reports are due out because if you are ill prepared, it will cost you.
To give an example, say you are trading the EUR/USD. In order to be successful, you must know the key dates the US government will be releasing macro data in addition to following ECB announcements and updates on Spain/Italy/Greece, in addition to individual country reports as I listed above. However, once you get into a routine and a “system” in which you go about your research, this task will be second nature.
On the other side of the scale, we have technical analysis. Technical analysis is based upon reading charts and the indicators that go along with the charts. In general, technical traders are not concerned with the underlying fundamentals, which has its positives and negatives. It is important to note that learning technical analysis tends to have a longer learning curve than fundamentals but can be equally, if not, more rewarding.
To begin you journey of learning technical analysis, I recommend educating yourself first and trading on a “paper” account, meaning you do not risk your hard earned money. Next, you must decide whether or not you want to specialize in “patterns” or “trends” or both for that matter.
Technical traders who rely on patterns are looking for certain set ups within the chart. For instance, a head and shoulders pattern is a bearish pattern. Below is a chart of the EUR/USD showing a head and shoulders pattern. As you can see, the two red circles are supposed to represent shoulders, while the green circle shows the head. If you are interested in this type of trading, I urge you go buy some investment books on this style of trading. I personally do not trade patterns because they tend to be unpredictable sometimes. Even if your chart shows a head and shoulders pattern, it doesn’t mean the underlying price is going to fall, necessarily.
I prefer to use a simpler method (in my opinion) called trend following. Trend following doesn’t require you to memorize patterns or anything of that nature. In fact, the only real on chart analysis I use is support and resistance levels. These are where the underlying price of the pair is having a hard time breaking below (support) or breaking out above (resistance). Furthermore, I rely on indicators such as moving averages, MACD, stochastics, etc. The chart below of the EUR/USD resembles the style a trader like me would appreciate more. I find this method more useful because once you understand moving averages, MACD, etc then this chart does a lot better job of telling you where the price might be going. The key to success here is really educating yourself on the different indicators. To be sure, there are hundreds of them but I would just stick with the basics indicators that I have listed above for now.
The bottom line here is that there are numerous ways to analyze forex pairs. Fundamental analysis and technical analysis are the two most popular forms and I would stick to just these two forms of analysis unless you are a skilled trader. Furthermore, a very popular question I get is “which form of analysis is better?” I can not personally answer that question for you but I can tell you that if you can mix both styles of analysis, you have just increased the probability of a successful trade. However you choose to trade, I wish you the best of luck and remember to educate yourself properly!