In order to maximise gains and reduce losses, traders typically turn to fundamental, technical and sentiment analysis. While fundamental analysis tells traders about intrinsic market values, technical analysis relies on past performance of a financial instrument. The third branch, sentiment analysis, is used to determine the general attitude of traders, which shapes the overall market mood, within a specific timeframe.
Of course, there’s no absolute way to tell which way the markets will go – and due to high volatility, losses are always a possibility. But, it helps to do your research.
Fundamental Analysis
When it comes to forex trading, fundamental analysis is all about examining factors that could have an effect on currency prices. A lot depends on the central bank of each country and the expected interest rates released by them. Interest rate hikes could increase the value of a currency over the long-term. Other factors, such as GDP, inflation rate, production growth, NFP releases, and so on hold importance for commodity traders as well. The aim is to identify which economy is booming and which isn’t. The day-to-day news releases are important for fundamental traders.
Technical Analysis
Technical analysts believe that what happened in the past will influence future market movements. Forex traders rely heavily on trend and chart analysis to figure out potential price actions. Forex, being a 24-hour market, provides a huge volume of data for technical traders, who then use it to predict future activity.
Support and resistance levels are used to determine whether to buy or sell a currency. The charts usually represent historical price movements, visually. The movements on the charts, created by price actions, provide clues about the supply and demand levels of specific currencies. There are other indicators, such as oscillators, volume and trend indicators, which help in identifying price trends.
However, many traders believe that indicators do not give foolproof answers, unless combined with market fundamentals. There is no guarantee that past performance will have an effect on future results.
Sentiment Analysis
The market is not only driven by fundamentals, but also short-term sentiments, which makes currencies volatile on a day-to-day basis. It is often seen that despite long-term fundamentals showing an uptrend, a currency remains down, due to an overall ‘bad mood.’ This bad mood means that the vast majority of traders are committed to a down position, due to some reason. Such sentiments often help traders assume a particular position.
Sentiment analysts are often referred to as contrarians. These traders invest against the majority view of the market, since they believe that the markets always tend to move against the existing sentiment, sooner or later.
Sentiment trading by itself is quite risky, since it involves uninformed trades. Uninformed traders may be moving the market prices away from fundamental values. However, used in combination with other forms of analysis, it can help in getting a clearer picture.
All three approaches are important. The best approach will be based on your risk tolerance, time restrictions and goals.