Marks Investing Blog

Fundamental analysis

Analysing economic information that indicates in which direction a currency is likely to move is called fundamental analysis.

What makes a currency move? A host of factors can affect the relativities between two currencies, but remember that if demand for a country’s goods or services is increasing, or the number of people wanting to invest there is growing, they must buy that country’s currency (at the same time selling their own) before they can buy its goods or invest in its companies. As more people buy, the currency tends to rise in value.

Investment in Australia, for example, is attractive when our economy is strong, when share prices on the stock market are expected to move higher, when companies are paying good dividends and when interest rates are rising. When these things are happening, the Australian dollar tends to move higher against other currencies. The Australian dollar is like a tiny share in the wealth of the nation as a whole. The economic indicators that show how healthy the economy is include:

• Interest rates – the dollar tends to move up when interest rates are rising.
• Global growth and demand for resources – Australia produces many of the commodities the rest of the world uses, including metals, coal and agricultural products such as wheat and wool. When demand for these goods is increasing, as it has been for most of the current century, this supports the currency. Any expected slowdown would tend to reduce the dollar’s value.
• The economic cycle – economies tend to have a phase of strong growth followed by a phase when growth slows. Share prices boom during the growth phase and tend to move lower (or move up only slowly) during the contraction phase. Growth tends to increase demand for the dollar; the dollar is more likely to fall in a slower phase. Indicators include housing statistics, retail and automotive sales figures and employment levels.
• Budget and trade deficits and surpluses – surpluses indicate strong growth and a rising Australian dollar; deficits the opposite.
• Inflation – inflation reduces investment returns, and rising inflation tends to reduce the long-term value of the currency. Governments tend to react to inflation by increasing interest rates, which may support the currency in the short term by restoring the return on investment. Indicators of inflation include the consumer price index and the money supply statistics.

Note that this is merely a beginning guide to a large subject. Ask your forex educator or foreign currency trading provider for further information.

Sentiment analysis

Analysing market sentiment means looking at all the information we have about the market that is not the price itself. If there’s one thing that’s constant about the market’s behaviour, it’s that traders tend to overreact, pushing prices to higher levels than their true value, and then overreact in the opposite direction, pushing to them to levels below true value. Sentiment analysis is all about picking these reactions.

Volume of trade is one indicator that can help determine in which direction the weight of trading money is flowing, and this can help reveal what the market believes is going to happen, which is market sentiment. It’s the difference between what the charts indicate the market is likely to do based on its past behaviour, and what it actually does as each unique market situation unfolds.

Although the indicators of market sentiment, such as moving averages and a currency’s average true range (ATR) are traditionally thought of as technical analysis tools, technical analysis focuses on past price movements. Sentiment analysis attempts to understand what is driving trader decisions for now and the immediate future.

Technical analysis

The market is like a balance that’s set in motion as new information about fundamentals comes to hand, swinging in one direction and then another, and from time to time finding a point where it may rest briefly until more new information is available. As all this happens, prices show patterns that tend to be repeated. Identifying these patterns by examining charts of past price behaviour is called technical analysis.

Technical analysis provides the basis on which most traders make their trading decisions. Fundamentals cannot be ignored, especially if you’re trading very short term (opening and closing positions on the same day), or holding positions at a time when economic news likely to affect the markets is about to break. As fundamental factors always show up in price formation, many traders make their decisions based on technical analysis alone. Expected news, such as the release of employment or inflation figures in a major economy, is often preceded by heavy trading as traders back their expectations, and a sudden move may follow the announcement if expectations are exceeded or unmet.

You will need to study technical analysis in some detail if you haven’t traded before. A recommended book is Charting Secrets by Australian author Louise Bedford. Your forex educator should focus on technical analysis and your forex provider may also have information on the topic, but there is a wide range of resources available on the internet (see Forex Resources).

Some providers include technical analysis, either within their software platform or as a separate add-on package. Charts allow you analyse market pattern and trend data and provide a visual representation of price and volume levels that you can use to determine the next likely move for a currency..

There is no such thing as absolute certainty when forecasting future price movements. The market can do anything, and often defies both logic and the forecasts of charts. Among the patterns and indicators traders use to forecast the way a market is likely to move are:

• Trend lines – lines joining higher and higher low points (uptrend) or lower and lower highs (downtrend). Prices breaking through these lines can indicate the beginning of a possible change in price direction.
• Moving averages – smooth out past movements and indicate a possible new trend if the price moves through the average.
• Reversal patterns – such as head-and-shoulders tops and bottoms, triple tops and rounded tops.
• Support and resistance – price points that a market has had difficulty moving through in the past.
• Relative strength indicators –show whether the market can be considered overbought (ready for a price drop) or oversold (ready for a rise).
• Fibonacci levels –levels that indicate a continued move in the current direction if breached.
• MACD – used to help spot early trends and trend reversals
• Cyclicity indicators – Markets go through cycles of bullish and bearish phases with periods in which they tend to return to their average. Cyclicity indicators help reveal such cycles.

Need to know

• Although many traders use only technical analysis, they do need to pay attention to news that may dramatically affect exchange rates.
• Technical analysis is an essential tool to help you predict which way the market is likely to move.
• It’s essential to have a basic understanding of chart patterns and indicators before starting to trade.

Thank you to Knowledge to Action for providing this information.