What Is the Best Method of Analysis for Forex Trading?

Forex analysis is used by retail forex day traders to determine buy or sell decisions on currency pairs. It can be technical, using resources such as charting tools. It can also be fundamental, using economic indicators and news-based events.

Types of Forex Market Analysis

Analysis can seem like an ambiguous concept to a new forex trader but it 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 economic data that come out of countries.

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

Technical analysis comes in the form of both manual and automated systems. A trader analyzes technical indicators in a manual system and interprets that data into a buy or sell decision. The trader is "teaching" the software to look for certain signals and interpret them into executing buy or sell decisions in an automated trading system analysis.

Automated analysis can have an advantage over its manual counterpart because it's 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 is that you want to establish a "big picture" view of a particular market in which you're interested. The markets are closed and not in dynamic flux over the weekend so you don't have to react to situations as they're unfolding but you can survey the landscape.

The weekend analysis will also 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.

Applying Forex Market Analysis

It's important to think critically about the tenets of forex market analysis. It can be helpful to follow a four-step outline.

1. Understand the Drivers

The art of successful trading is due in part to understanding the current relationships between markets and the reasons that these relationships exist. It's important to get a sense of causation and to remember that these relationships can and do change over time.

A stock market recovery might be explained by investors who are anticipating an economic recovery. These investors believe that companies will have improved earnings and greater valuations in the future as a result. This could mean that it's a good time to buy but speculation based on a flood of liquidity could be fueling momentum. It could be that good old greed is pushing prices higher until larger players are on board so the selling can begin.

2. Chart the Indexes

It can be helpful for a trader to chart the important indexes for each market for a longer time frame. This exercise can help to determine relationships between markets and whether a movement in one market is inverse or in concert with the other.

Gold was being driven to record highs in 2009. Was this move in response to the perception that paper money was decreasing in value so rapidly that there was a need to return to the hard metal? Or was it the result of cheap dollars fueling a commodities boom? It could have been both or it could have been market movements driven by speculation.

3. Look for a Consensus in Other Markets

You can gain a perspective on whether the markets are reaching a turning point consensus by charting other instruments on the same weekly or monthly basis. Take advantage of the consensus to then enter a trade in an instrument that will be affected by the turn.

Japanese exports could be affected if the USD/JPY currency pair indicates an oversold position and that the Bank of Japan (BOJ) could intervene to weaken the yen. But a Japanese recovery is likely to be impaired without any weakening of the yen.

4. Time the Trades

There's a much higher chance of a successful trade if you can find turning points on the longer timeframes and then switch down to a shorter time period to fine-tune an entry. The first trade can be at the exact Fibonacci level or double bottom as indicated on the longer-term chart. A second opportunity will often occur on a pullback or test of the support level if this fails.

Acquiring Forex Trading Systems and Strategies

A day trader's currency trading system may be manually applied or the trader may make use of automated forex trading strategies that incorporate technical and fundamental analysis. These are available for free, for a fee, or they can be developed by more tech-savvy traders.

Both automated technical analysis and manual trading strategies are available for purchase on the Internet but there's no such thing as the "holy grail" of trading systems in terms of success. The seller wouldn't want to share it if their system was a fail-proof money maker. This is evidenced by how big financial firms keep their "black box" trading programs under lock and key.

The Bottom Line

There's no "best" method of analysis between technical and fundamental analysis for forex trading. The most viable option for traders is dependent on their time frame and access to information.

Technical analysis may be the preferred method for a short-term trader with only delayed information on economic data but real-time access to quotes. Traders who have access to up-to-the-minute news reports and economic data may prefer fundamental analysis. It doesn't hurt to conduct a weekend analysis when the markets aren't in a constant state of fluctuation.