Technical Analysis and Fundamental Analysis
In Part 1 of Introduction to FOREX Trading we looked at the origins, structure and proliferation of today’s FOREX market. In this article we’ll discuss the two investment strategies used by FOREX traders: Technical Analysis and Fundamental Analysis.
Most small- to medium-sized investors in the FOREX markets use the form of investment strategy known as Technical Analysis. This technique stems from the assumption that all information about the market and a particular currency's future fluctuations can be found in the price chain. In other words, all of the factors which have an effect on the price of the currency have already been considered by the market and are therefore reflected in the price. The investor who uses Technical Analysis bases his investment decision on three essential suppositions: that the movement of the market inherently considers all factors; that the movement of prices is purposeful and directly tied to these events; and that history repeats itself. This investor considers the highest and lowest prices of a currency, its opening and closing prices, and its volume of transactions. He or she does not try to predict long-term trends, but simply looks at what has happened to that currency in the recent past, and supposes that the small short-term fluctuations will generally continue as they have before.
An investor who utilizes Fundamental Analysis studies the current situations in the country of the currency, including such things as economy, political situation, and other related information. A country's economy can be quantifiably defined by measurements of its Central Bank's interest rate, its unemployment level, its tax policy and the rate of inflation. The prudent investor also knows, however, that less measurable conditions and occurrences can also impact a nation’s economy. He or she must furthermore keep in mind the expectations and anticipations of other market participants. Just as in any stock market, the value of a currency is also based in large part on the perceptions of and anticipations about that currency, and not solely on the reality of its condition.
While the risk certainly is substantial, the ability to conduct marginal trading in the FOREX market allows for potentially enormous profits relative to the initial capital investments that are required. The sheer size of the FOREX prevents virtually all attempts by anyone to influence the market for their own personal gain. This has the effect of making the investor feel quite confident that when trading in foreign currency markets he or she has the same opportunity for profit as do other investors around the world. It must be stated, however, that, as with any investment, losses are a possibility. They can, and do, occur. And for the same principle that gives marginal trading its potential for huge gains, the possibility of huge losses is just as great.
Although investing in the FOREX using short-term strategies requires definite assiduousness, experienced investors who utilize a technical analysis can generally feel confident that their ability to read the daily fluctuations of the currency market are sufficient enough to supply them with the knowledge necessary to make informed and prudent decisions.