An analysis is nothing but the rationale behind the trade or the reason for it. There are different types of analysis that traders can carry out and take trades based on it. Each type has its pros and cons and you should know them before you choose any.
What is an analysis?
The financial markets are volatile and the barrier to entry in terms of capital required is not so low, hence if you want to trade then you will have to dedicate a certain sum of money for this purpose.
Thousands of traders all around the globe participate in this market for their own various reasons which make the forex markets volatile.
These traders often perform some sort of analysis before placing trades on their foreign exchange terminals. This analysis is nothing but the reason for their trades.
The analysis gives the trader the ‘why’, ‘when’, and ‘where’ of their trades.
For example, a trader has a watchlist of several currencies and has an analysis plan in place that would give him signals to enter and exit his trades. The trader gets a signal to buy the USDJPY currency pair according to the analysis.
This answers the questions -
1. Why to enter - Because the analysis gave the signal.
2. When to enter - When the criteria of the analysis are met.
3. Where to enter - Whichever currency pair meets the criteria of the analysis.
Types of analysis
Forex traders use a variety of strategies and techniques to determine the best entry and exit points and timing to buy and sell currencies.
Market analysts and traders are constantly innovating and improving upon strategies to devise new analytical methods for understanding currency market movements
Now that we know what an analysis is basically, let’s explore the different methods by which the traders make these analyses.
1. Technical analysis
In technical analysis, traders look at historical price movements and determine the current trading conditions and potential price movement.
Technical analysis is one of the most widely used types of analysis in which traders study the price movement.
In short, technical analysis is a method of analysis by which traders trade purely based on charts of the price movement of the currencies.
There are various chart patterns, candlestick patterns, and indicators that technical traders apply to the charts which helps them make trading decisions.
Traders that make their trading decisions based on technical analysis are called technical analysts.
2. Fundamental analysis
Currencies of various countries are listed on the foreign exchange market and there is often so much happening in some of the other countries that affect the daily price movement of the currencies.
Every country has different economic news scheduled throughout the day and this news directly reflects the condition of the economy of the country.
If a country's economy is weak, the currency will be weak and if a country's economy is strong then the currency will be strong.
Many traders use the news to do a complete analysis and predict if the economy of a country is going to get strong or weak. And based on this they predict future price movements in the forex market.
The traders who use fundamental analysis to place a trade are called fundamental traders.
Fundamental analysis is the interpretation of such macroeconomic changes in order to make trading decisions.
There are several reports that are released daily in countries all over the world that indicate whether a country has done well over time or will do well in the times to come.
Fundamental analysts utilize this information and capitalize on it by taking positions in currencies on the foreign exchange markets.
3. Sentimental analysis
There are millions of traders out there in the forex market and every trader has their own belief and bias. Like at some point in the market there are traders who buy and at the same point there are traders who sell.
The outcome of where the price will move depends upon the number of buyers and sellers present in any market.
At times when buyers are more than the sellers then the price will move up and when sellers are more than the buyers then the price will move down.
In sentimental analysis, the traders look for the data of what other traders feel about a particular currency pair and then look out for what is the bias of most of the traders.
If the buyers are more then they look for a buying opportunity and if sellers are more then they look for a selling opportunity.
Traders place these trades with a bias of the price of a currency either rising or declining. Sentiment analysis allows traders to gauge the prevailing bias at that particular moment and trade in direction of that bias.
The traders that use sentiment analysis for taking trades are called sentiment analysts.
4. Quantitative Analysis
There are various mathematical and statistical models out there that allow individuals to analyze data.
In quantitative analysis, these mathematical and statistical models or formulas are applied to the price movements of currencies in order to make trading decisions.
This type of analysis is the most complex of all as the mathematics behind this involves lots of intricate variables which a normal person would not be able to comprehend.
The traders that apply quantitative analysis to make trade decisions are called quantitative analysts.
Which is the best?
I am sure you are expecting me to pick the best type of analysis from the above-mentioned ones, but I will not do so. There can never be the best type.
One type of analysis might work for you while another type won’t. This is completely subjective.
Trading in the foreign exchange markets has been going on for a long time now. Since a lot of time has been spent in trading, lots of analysis methods have been developed by the traders.
As it is said that no two persons are the same, every person has a personality of his own, so different traders may use different analyses to take trades.
If you are someone that likes to look at charts and visual representations of price then maybe technical analysis is for you.
On the other hand, if you need to analyze reports and news events in order to develop a bias then you should try out fundamental analysis.
If you are able to gauge the sentiment of the market and figure out where the majority is at then maybe you stick to that and if you are good with quant stuff then you should go ahead with quantitative analysis.
The important thing here is that you know what each type brings to the table, you try your hand out at these types, and then decide what is best for you.
What type of analysis do you follow?
Do let me know what type of analysis you follow in order to develop a bias to take trades. I’d also like to know your trading strategy or set up for the analysis that you carry out.
Share this blog post with every trader you know and let them also explore the various types of analysis that are available to traders.
Feel free to ask questions or queries through the comments section and I will get back to them for sure.