Types of Market AnalysisEssentially, there are two headline types of analysis traders can undertake when looking at markets:
- Technical analysis
- Fundamental analysis
Technical analysis, sometimes split into two types of analysis (technical and price action), is the concept of looking at current and previous price movements to attempt to determine where a currency is going to go. This is done almost exclusively on charts.
The reason most people like this type of analysis is that it is relatively quick (depending on your level of analysis), it presents a good overview, can be shown to work and is typically less subjective.
Essentially, then, the idea is to use previous price movements to predict future price movements.
Some say that future price movements are ‘random’ and therefore cannot be predicted from a chart. However, when many, many analysts study the same chart using the same tools, the future price predictions can become self-fulfilling prophecies. This is true more so in Forex markets than, for example, individual equities. These standard tools are really indicators that use the underlying price data to predict price movements based on previous empirical evidence of events reoccurring.
Part of the reason some technical techniques work is that they reflect some underlying movement in the order book. As mentioned above, in some cases this is because if enough people follow the technique, it becomes a self-fulfilling prophecy, so many only work in very specific conditions.
Beyond the price charts, technical analysis also focuses a lot on key levels, turning points and potential ‘plays’, such as ‘if this happens, then this is likely to happen’ or ‘if that happens, then something else is more likely to happen’.
Fundamental AnalysisFundamental analysis is a way of looking at the market by analysing economic, social, and political forces that affect the supply and demand of an asset.
This should, in theory, be present perfect information, and therefore certainty, but the challenge is that a lot of it is subjective and can be interpreted in many ways.
The idea of all this information is that it translates into underlying orders in the order book and thus creates the real supply and demand mentioned earlier.
There will be more detail on how different market themes can impact the fundamental outlook in greater detail in a future lesson, but for now, the general concept is that if a country’s economic outlook is good, then their currency should be worth more.
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