What are the Best Forms of Forex Analysis?

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Contributor, Benzinga
Updated: August 25, 2022

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Operating in the huge foreign exchange or forex market typically necessitates using at least some market analysis to make a trading plan profitable. Many forex traders use several complementary market analysis methods to achieve success. This article discusses the best forms of forex analysis and how traders use them to get better currency trading results. You can read more from Benzinga about forex trading.  

What Does a Forex Analyst Do?

In general, a forex analyst performs a detailed examination of factors that can move the currency market or that can potentially predict its future trajectory. Many successful forex traders attribute their profitability to the quality of the market analysis they perform. Forex market analysis can also help you structure your thoughts and observations regarding the currency market to result in an actionable trade idea. 

Three Types of Forex Analysis

Profitable forex traders typically analyze the currency market’s prospects in one or more of three basic ways to determine whether they should position themselves long, short or neutral on a particular currency pair of interest. These common market analysis methods consist of technical, fundamental and sentiment analysis, and each method is described in further detail in the sections below. 

Technical Analysis

The most popular market analysis method among currency trading professionals is forex technical analysis. This method assumes that market exchange rates discount all available information, which simplifies the analysis process substantially. Technical forex analysts typically look for patterns and levels of support and resistance on exchange rate charts. They also usually compute technical indicators from market observables that can give them objective trading signals.

Fundamental Analysis

Those using forex fundamental analysis typically look at how economic and geopolitical factors might affect national currencies. Although the forex market can and does shift its focus onto different economic indicators from time to time, these major fundamental indicators tend to affect relative currency values the most:

  • Jobs data
  • Central bank monetary policy and benchmark interest rates
  • Inflation data
  • The trade balance
  • Gross domestic product (GDP) growth 
  • Commodity prices

Sentiment Analysis

Of all the forex analysis methods, sentiment analysis is the least used among currency traders. This factor partly arises because the forex market is so decentralized that no sentiment indicator exists that includes all market participants. 

Some currency traders might use the Commitments of Traders (COT) report that the Commodity Futures Trading Commission (CFTC) issues to show currency futures positioning, and hence market sentiment, on the Chicago Mercantile Exchange (CME). Certain retail forex brokers also offer sentiment data by showing an anonymous aggregate of their clients’ long or short positioning. 

Such sentiment indicators only reflect trader attitudes in a very small percentage of the huge forex market, however, which is why so few currency analysts use them. 

How to Apply Forex Market Analysis

Some tips for how to apply forex market analysis that forex traders can keep in mind when trading a currency pair appear below. 

Understand Market Drivers

The forex market is largely driven by capital flows between countries. Such flows can be related to the international trade in goods and services, commodity pricing and investment opportunities. Understanding the underlying factors that drive the currency market is an important part of successfully applying forex market analysis.

Chart Currency Indices

Each national currency is traded against every other national currency in the forex market. You can create and chart an index for one currency to illustrate how it has fared overall relative to a basket of other currencies for a given timeframe. Reviewing this index and its evolution over time can give you useful insight into the underlying trends for an individual currency. Futures contracts for U.S. dollar and euro indices are traded on the Chicago Mercantile Exchange (CME). 

Look for a Consensus in Multiple Markets

You can sometimes determine if a forex pair is reaching a turning point in its exchange rate’s trajectory by looking at the charts of other assets over the same time frame to see if a similar reversal has already occurred or is currently in progress. 

Pick and Time Your Trades Wisely

You have a better chance of trading forex successfully if you can first identify major long-term market turning points, and then fine-tune your entry point using technical analysis. Also, having the patience to wait for good trades and the discipline to stick to your trading plan will generally benefit you over less-prepared traders. 

Forex traders often use fundamental economic indicators to identify the causes for market movements and to assess the long-term prospects for a currency pair. For example, they might analyze a country's GDP, interest and inflation rates and job and housing markets to get insight into the strength of that country's economy and hence its currency.

Forex Trading Strategies

Most successful forex traders operate with a plan they have strategically developed ahead of time. This strategy helps remove the emotional element from trading that can interfere with a trader’s profitability. Such a plan will generally include one or several forex strategies that lay out how the trader will enter into and exit positions in one or more currency pairs.

These days, some currency traders might opt to allow technology to assist them in their trading endeavors by using fully automated forex trading robots that have a complete trading strategy coded into them. 

Frequently Asked Questions

Questions & Answers

Q
What is the most effective forex indicator?
A

The most effective forex indicator can depend on market conditions. With that noted, many forex traders use moving averages to identify trends and the Relative Strength Index to indicate upcoming market reversals.

Q
Does technical analysis work on forex?
A

Yes, technical analysis works on forex, and it is typically the preferred market analysis method used for timing transactions among experienced forex traders.

Q
Do pro traders use indicators?
A

Yes, some professional forex traders use both technical and fundamental indicators, although they can operate in a variety of different ways.

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