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Forex Trading | How it works and what types of analysis exist

Forex Trading | How it works and what types of analysis exist

In a financial market, trading consists of buying and selling assets, such as shares, futures, currencies, or derivatives. To trade and obtain benefits, we must speculate on the movements in the price of assets. Therefore, trading is usually done in the short term. With the following post, we will focus on trading on Forex operations.

Forex Trading

Unlike stocks or commodities, currency trading is not done on exchanges but directly between two parties in an over-the-counter (OTC) market. In this case, the forex market will be run by a global network of banks, which is generally distributed in 4 main forex trading centers with different time zones: London, New York, Sydney, and Tokyo.

Now, you must know that there are some types of currency markets, such as:

  •  Forward currency market: where a contract is agreed to buy or sell a fixed amount of a currency at a specified price, to be settled on a specified date in the future or within a range of future dates.
  • Spot Forex Market: where the physical exchange of a currency pair takes place at the exact point that the trade is settled, ie, ‘on the spot,’ or within a short period of time.
  • Foreign exchange futures: in this, a contract is agreed to buy or sell a certain quantity of a specific currency at a price and a date established in the future.

Three Kinds of Market Analysis

Three kinds of market analysis help us to be able to trade. These three types of analysis are fundamental, technical, and sentiment.

Fundamental Analysis in Forex

Fundamental analysis is a way of looking at the market by analyzing the economic, political, and social forces that affect supply and demand in the foreign exchange market. For this, knowing the world economy’s leading events and macroeconomic data is essential. An excellent tool to know when these economic announcements will be officially produced is the Forex economic calendar.

Fundamental analysis assumes that if a country’s current or future economic outlook is good, its currency will strengthen. If the demand for a country’s goods and services increases, or the number of people who want to invest there is growing, they will need to buy that country’s currency before they can buy its goods or invest, and then the value of the currency is likely. let it go up.

Fundamental analysis within the foreign exchange market

Some of the economic indicators that show how the economy is doing are:

  • Interest Rates. For example, the Euro tends to rise when interest rates are rising.
  • The demand for resources. Raw materials are produced in the Euro Zone, including metals, coal, and agricultural and livestock products such as wheat and wool. When the demand for these goods is growing, this strengthens the currency.
  • Budgetary and Commercial Deficits and Surpluses. Surpluses indicate strong, deficits indicate the opposite.
  • The economic cycle. Indicators include housing statistics, retail sales, car sales figures, and employment levels. When the unemployment data and the United States Consumption Index are known, they influence the price of the dollar
  • Inflation. Inflation reduces investment returns, and rising inflation tends to reduce the long-term value of a currency. Indicators of inflation include the consumer price index and money-in-circulation statistics.

Technical Analysis

Technical analysis is used for traders to study price movements. This technique assumes that a person can look at a history of price movements and determine current trading conditions and potential price movements. The main reason to use technical analysis is that in theory, all current market information is reflected in the price.

If the price reflects all the information that is in the market, then the price action is all one needs to make a trade. Then we can see a technical analysis of the EUR / USD in the following image. It is a candlestick chart that indicates several supports and resistances and several indicators, RSI, Stochastic, and MACD, to know when to enter or exit this currency pair. According to these three indicators, it seems not a good time to enter or exit the Eur/Usd.

Technical analysis in forex

Among the patterns and indicators that traders use to forecast how the market is likely to move to include:

  • Trend lines: lines linking the highest points and the high points (upward trend) or the low points and the lowest points (downward trend). Prices breaking these lines can signal the beginning of a possible change in price direction.
  • Moving averages: They flatten past movements and indicate a possible new trend if the price moves through the average.
  • Relative Strength Indicators. They show whether the market can be considered overvalued (to sell) or undervalued (to buy). Some of the most used action pattern indicators are RSI, Williams, MACD, Stochastic, and Bollinger. To decide to buy or sell, it is advisable to use several indicators. It must be remembered that the indicators can contradict each other for the same currency pair analysis. Therefore, it is essential to use several to know if you have to buy or sell.
  • Fibonacci levels. They are levels that indicate that a continued movement in the current direction has been broken.
  • Convergences / Divergences of the Moving Average. They are used to help show early trends and trend reversals.
  • Reverse Patterns. Among these are, for example, figures such as: shoulder-head-shoulder, ceilings and floors, double ceilings, triple ceilings, and rounded ceilings.
  • Supports and Resistances. They indicate price points that a market has needed help breaking through in the past.

Sentimental Analysis

The opinions and thoughts of each trader, which are expressed through whatever positions they take, contribute to forming the general sentiment of the market. One thing that is constant in the market behavior is that the operators tend to overreact, pushing the prices to levels higher than the actual value.

Sentiment analysis tries, above all, to detect these reactions. That is, it tries to understand what is driving the operator’s decisions at the present moment and in the immediate future regarding the behavior of currencies.

Trading Systems

Trading systems are a set of well-structured mathematical rules on which many investors base their investment operations. The great advantage of creating trading systems that work with computer programs is automating buying and selling operations in many existing markets.

Finally, remember that the forex market is made up of currencies from all over the world, making exchange rate predictions difficult since many factors can contribute to price movements. However, like most financial markets, Forex is driven primarily by the forces of supply and demand. For this reason, it is vital to understand the influences that drive price fluctuations and how Forex trading works.

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