Forex Analysis: What it Means, How it Works, Example

What Is Forex Analysis?

Forex analysis is the practice of examining the changes in currency pair prices and the forces influencing those price changes. It is used by forex traders who buy and sell currencies with the goal of making a profit. Fundamental and technical analysis methods are both used in forex trading, with many traders using a hybrid approach that combines both techniques.

How Forex Analysis Works

The foreign exchange market is the largest market in the world, with trillions of dollars changing hands on a daily basis. Retail traders and financial firms both regularly engage in forex analysis to try to profit from this large and important market. Today, the forex market is open 24 hours a day, five days a week, with most activity concentrated in global trading hubs such as London, New York, and Tokyo.

Unlike the stock market, in which investors can purchase shares of individual companies, the currencies traded in the forex market always trade in pairs. When one of the currencies in a pair is purchased, this necessarily means that the other currency in the pair is sold. Some of the most commonly traded currency pairs in the world include USD/CAD, EUR/USD, and EUR/JPY.

Forex analysis is the practice of determining which currency within a pair is likely to be stronger over a given period of time. Forex traders can then use this knowledge to purchase the currency that they expect to increase in value or to sell the currency they think will decline in value. To help make these predictions, forex traders will study a range of sources. These include fundamental factors, such as the state of the nation’s economies, the price of relevant commodities such as oil, or any major news events affecting international economics. Technical factors are also considered, such as the recent price history of the currency relative to its historical averages.

Real World Example of Forex Analysis

To illustrate, consider the case of the USD/CAD currency pair, which is one of the world’s most heavily traded pairings. Canada and the United States are close trading partners, which means that a large amount of foreign exchange takes place between them for reasons such as cross-border trade, travel, and investment.

In looking at this currency pair, forex traders who use fundamental analysis may look at factors such as the interest and inflation outlook for both currencies. They will also look at factors such as employment, which may provide insight into future interest rate trends. A strong economy will tend to push interest rates up, attracting more investors into that currency and into that market to benefit from the higher interest rates. Because the Canadian dollar tends to move with the price of oil, traders may also factor in expectations about the future direction of oil prices.

Technical analysts, meanwhile, might look for trends and ranges within the price history of the USD/CAD. A trend will provide the overall direction the currency pair is moving, while ranges may indicate areas of support or resistance the price is approaching. They may also use technical indicators in an attempt to find a rhythm or pattern in the price movements. By charting these patterns, analysts can try to anticipate how the price will move within the pattern, and predict when it will break out of its historical range.