People analyze markets in very different ways. There are those that trade psychologically, those that invest with their heart, and those that rely on technical charts and mathematical data. There are also those that stick rigidly to a strategy, those that use strategies simply to help identify potential trades, and those that would scoff at the simple suggestion of an algorithmic strategy.
Regardless of how you trade, though, you should fall into one or more of three basic categories, assuming that you are taking Forex trading seriously, which you absolutely should if you intend to invest any of your money in currency.
In fundamental trading, a trader decides when to enter or exit a trade based on the market news because financial news has a short validity period. A 1-month-old news is too old to base your trading on. Whereas in stock trading a past news may still be valid at times.
The primary fundamental analysis of a currency takes into account that currency’s interest rate.
While a fundamental trader will look at other factors, including GDP and inflation rates among others, they will primarily be doing so in order to find out its effect on the interest rate.
There is a correlation between interest rates and currency, but those that trade solely using fundamental data must also know whether general investment sentiment is risk averse or whether traders are open to taking on risk in the hope of generating reward.
The sentiment, in the case of Forex analysis, means the general and overall sentiment of investors and requires analyzing the total trades and direction in which those trades have been made.
For example, using sentiment analysis, you may be able to recognize that the majority of traders are buying a particular currency.
The sentiment trade is one that will look to take advantage of the fact that these buyers are also future sellers, and they will take a position by calculating when they believe buyers will become sellers and aim to profit in this way.
A sentimental Forex trading involves three things
- Identifying a Trend
- Crowd behavior
- Watching the crowd change trend
With this style of trading, you analyze the price chart for technical patterns and signals. Technical analysis is widely used, and it relies strictly on analyzing charts and data to find trends in exchange rates.
These trends, as well as technical indicators, are then used to determine an exact point where the trader should enter and exit a currency pair.
Charts and charting platforms are readily available and can arm you with considerable data. It is the massive levels of liquidity in the Forex market that make technical analysis so popular.
Data analysis becomes more reliable as you have access to more data, and there is certainly no lack of data in the currency market; analyzing it effectively, on the other hand, is not guaranteed.
In truth, most people analyze the market using a hybrid means of analysis that combine two or more these styles of analysis.
Many sentiment and fundamental analysts, for example, will incorporate some degree of technical analysis, and to be an effective trader, it is usually beneficial to understand these types of analysis in order to be able to identify why the market is moving in a particular direction.