Lesson 6 – Fundamental and technical analysis

Required for the forex course

Forex account: free account at Markets.com

Duration per lesson: about 10 minutes

What is the best forex strategy? Well, THE BEST forex strategy does not exist, but all successful strategies have one thing in common: they anticipate the next move of the market. The exchange rate of a currency pair is determined by the law of supply and demand. For example, if many people believe that the price of the euro will rise against the dollar, they will start buying the EUR / USD. That automatically boosts the price of this currency pair, causing the Euro to appreciate against the dollar.

Whenever you take a position it is important to anticipate what the market is going to do. Never trade against the market, because the market is always right; by definition, forex prices will reflect the expectations of the crowd, even if there is actually no good reason behind it.

Anticipating what the Forex market is going to do seems easier than it is, because the crowd is not screaming to everyone what he or she is going to do. Just like you, all those other millions of Forex traders are behind their PC screens placing orders without you seeing them. There are, however, means to predict what all these people are going to do: fundamental analysis and technical analysis. By developing a better understanding of these techniques, you learn to predict prices faster and better.

Fundamental analysis & Technical analysis

In general, the Forex market distinguishes two “schools” when it comes to obtaining information: that of Fundamental analysis and that of Technical analysis.

Fundamental analysis

In fact, you have already briefly encountered fundamental analysis previously in this course. Fundamental analysis is the study of economic, political and international events and their impact on exchange rates. Put more simply: studying the impact of the news of stock markets. This is exactly how we determined what positions we wanted to take in previous lessons.

Technical analysis

Technical analysis is often considered to be more successful, although almost everyone agrees that a mix both is what makes a successful trader. Technical analysts do not look at actual events, but only at the price and price movements. The idea behind this is that all developments in the economy are ultimately incorporated in the price and that, therefore, only the price trend can be used to determine the future direction of the price.

The six most important figures for technical analysts:

  • Open: the opening price at the beginning of a period
  • High: the highest quoted price within a period
  • Low: the lowest quoted price within a period
  • Close: the closing price at the end of a period
  • Volume: the number and size of transactions throughout the market within a period
  • Open Interest: the total number of open positions in the entire market at a specific moment

Because Forex is an open market (in contrast to the stock exchange, for example), analysing the last two figures (volume / open interest) is very complex. However, the first four are easy to follow. Forex traders even use special candlestick charts that accurately represent these figures for each period. To find out more about candlestick charts read this article.

Technical analysis in practice

To give you an idea of the kind of information you can get from graphs as a technical analyst, we show you an example below. It is a graph of the GBP / USD currency pair over the past seven days.

From this chart two important issues can be deduced. First, the GBP / USD is clearly in an uptrend. That is, the exchange rate has been moving up for a while. Because trends are more likely to continue than to reverse, we could speculate on a further increase.

Second, the price seems to move within a certain bandwidth, which is about 100 pips wide. Because there is an uptrend, the bandwidth itself is trending up as well. Every time the currency pair touches the top or the bottom of the bandwidth, the price starts moving in the opposite direction.

Right now – the right-hand end of the graph – the price is in the middle of the trend channel, making it difficult to make a statement about what will happen next. This is not a good moment to open a position. But at the circled points in time, where the price touched the trend channel, it could have been a good moment to open a trade, speculating on a short-term reversal of the price. The first and fourth points were good moments to open a long position and speculate on a price increase. The second, third and fifth points offered opportunities for a short position to speculate on a price decrease.

More advanced indicators

In the more advanced forex articles we explain much more techniques to perform technical analyses. Make sure not to learn too many techniques simultaneously. Reading over a 100 pages about technical indicators without ever doing a trade yourself, will only make it more confusing. Instead, try to make a few trades based on a certain strategy or indicator. Once you understand how to apply the indicator, you try adding new technical indicators to practice with.

Lesson 1 – Why Forex: “The Turtles”

Lesson 2 – What is Forex

Lesson 3 – Interpreting Forex prices

Lesson 4 – How to open a forex position

Lesson 5 – News and rumours

Lesson 6 – Fundamental and technical analysis

Lesson 7 – Forex and psychology

Lesson 8 – Ten trading tips for beginners