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A Guide to Forex Market Analysis

By Jeffrey Cammack Updated: July 11th, 2019

Forex Market analysis is used by traders to spot opportunities in the Forex market.

In this guide we are going to examine the three main forms of market analysis used in Forex trading and how they differ. By the time you have finished reading you will be able to implement the basics of market analysis in your own trading.

Forex Market analysis is generally split up into three main categories. 

Each category requires different knowledge or skills.  They are:

  1. Technical Analysis
  2. Fundamental Analysis
  3. Sentiment Analysis

It’s important to know that there is no best type of market analysis and you will frequently use all three together to make your trading decisions. 

Technical Analysis

Technical analysis is the study of historical movements in price (price action) to forecast future price movement – most of this study takes place on charts.

Technical analysis theory argues that all current market information is reflected in the price of an asset – it therefore follows that price action is all a trader needs in order to predict future price movement.

A trader employing technical analysis will rely on technical indicators to better gauge price movements and to confirm price patterns.

The most common type of technical analysis is support and resistance trading. A support level represents a zone on the chart from where the price was rejected (failed to break through) at least two times. Inversely, a resistance level represents an area on the price chart from where the price reacted lower at least two times.

Note: Connect two bottoms to draw your support level and connect at least two tops to draw your resistance line.

Support & Resistance Lines Example

How to identify trends

You can often identify a market trend or market direction from the price. Usually, a series of higher high and higher low swing points is considered an uptrend while a series of lower lows and lower highs is regarded as a downtrend.

A trader can also use trendlines – technical tools available on all trading platforms – to better gauge a trend.

How to spot an uptrend (Bullish market)

Technical indicators are another tool that can help you make better trading decisions. One of the most common indicators used by traders are oscillators, which can signal overbought areas –  from where the price might move lower – and oversold areas – from where the price can rally.

Stochastic Indicator

In the above figure, we have an example where we used the stochastic indicator to spot possible reversal zones on a price chart.

Typically, when the stochastic indicator shows a reading above 80, it signals an overbought trend and a possible reversal. When the stochastic indicator shows a reading below 20 it indicates an oversold trend and a possible reversal.

Fundamental Analysis

Fundamental analysis involves studying economic trends and geopolitical events that might affect currency prices. In other words, it’s the study of financial news and economic data.

The most important economic data to watch for includes:

Because the United States has largest economy in the world, US macro data tends to have the most significant impact on the Forex market.

In fundamental analysis it is essential to understand how economic news will impact currency exchange rates – this requires a good understanding of economic theory and geopolitics. Usually, the fundamental forces that drive market price can be the catalyst for larger trends.

For example, interest rates are one of the biggest drivers of changes to exchange rates. When central banks such as the Federal Reserve in the US or the European Central Bank change the rates for the USD or EUR, respectively, the market reacts with high volatility – creating significant trading opportunities.

Example follow the US Federal Reserve hiking interest rates on lending.

Sentiment Analysis

Sentiment analysis is used to gauge how other investors and traders feel about a particular currency pair. Sentiment analysis is often used as a contrarian indicator –  the premise being that the majority of Forex traders are usually wrong, so trading against them over time will pay off.

The simplest method to gauge market sentiment is to look at the COT report which provides a breakdown of how traders are positioned in the market. Usually, this strategy implies that if the majority of speculators are buying very aggressively, you should take a trade in the opposite direction which, in this case, is selling.

Note: The same rule applies in the case when speculators are selling an extreme number of contracts. This means you should buy instead.

Example: sentiment analysis in action

Conclusion

There are many different ways to analyse the market, but there is no perfect method, and the best traders will combine all three forms listed here.

Knowing your own strengths and weaknesses will help you choose which of these three ways to rely on most in your market analysis.

Once you have a firm grasp of what to look for on a price chart, it won’t look too complicated. Fundamental analysis will help you spot the larger trends. Last, but not least, sentiment analysis can give you further insights into what direction the market is more likely to move in.

Trading Forex and CFDs is not suitable for all investors and comes with a high risk of losing money rapidly due to leverage. 75-90% of retail investors lose money trading these products. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.