It is said in trading, that the “trend is your friend” and that is true. For instance, if a trend in the EUR/USD market is moving higher, than only establish long positions. If however the market is trending lower, than only establish short positions.
How you determine if any particular market is trending lower or higher is by looking at your bar charts you receive when you establish a trading account with a forex market. If your bar chart shows prices moving higher, based on a particular time frame, than you know that market is trending higher. If those bar charts than show prices moving lower based on a particular time frame, than you know that the market is trending lower.
Those two types of analysis is:
1) Fundamental Analysis
2) Technical Analysis
Fundamental analysis is the study of the economics of supply and demand for any commodity, security or currency. Too much supply without the demand, will typically drive prices lower. Too much demand without the supply will typically drive prices higher.
Traders who trade by using fundamental analysis utilizes weather reports, Gross Domestic Product (GDP) reports, interest rates hikes or cuts by a country’s monetary committee like the federal reserve.
In the end, it is fundamentals which drive the market prices both higher or lower.
Technical analysis is the study of price action over a specific period of time, using price charts to gage trends to verify if markets are trending higher or lower.
The 3 main premises of technical analysis approach is that price history repeats itself over time, price action moves in trends and the markets always discount fundamental news ahead of time.
Here’s what these 3 premises means to the trader:
Price history repeats itself over time – both fundamental analysis and technical analysis overall believe that this is a fact. Gasoline prices reach a peak in prices during the summer months because this is when people normally travel for vacations. On a technical analysis basis, price of gasoline starts to trend higher in March and reaches a peak in July. During August prices decline, and then rise one more time right around September for the last U.S. holiday (Labor day) before school starts.
Although this is an example of a particular commodity and not a currency, the concept is the same. There are some instances that aren’t seasonal, but fundamental. Like monetary policy of a country. If the U.S. Federal Reserve cuts interests rates, this is usually bearish (trending lower) for the U.S. dollar.
Price action moves in trends – Sticking with are example in gasoline, the prices of gasoline is sold in U.S. dollars. As the dollar weakens, this could be bullish for gasoline prices because other currencies that are worth more than the U.S. dollar, can buy more gasoline, with less money. This can create trends. Going by Newton’s law of physics, a trend in motion is more likely to continue in that motion than reverse. Remember, it is best to trade with the trend as this trend has tremendous amount of momentum and strength in that particular direction.
The market discounts everything ahead of time – Fundamental reports are usually released on a specific dates. There are usually leaks of this information by other reports, analyst that follow these securities or there are other data which provide hints on what an actual report is going to be before it is even released. Because markets are priced in real time, the market traders bid up or sell down prices based on other preliminary reports before the main one is released.
The market than takes this information into account by either adding to the current price or subtracting from current price based on this assumption. At the time of release from the actual report, if the market assumed wrong, prices will immediately reverse and go the other way. If however the markets interpretation was right, but not as aggressive, the markets will then compensate and surge in that direction.
If the market was correct and wasn’t either overly aggressive or pessimistic, than the market will take it in stride and not move drastically either way. This will happen with all information that is scheduled to release.
Information that is unscheduled or that breaks out without the market having a chance to discount the information, such as terrorist attacks or an unexpected rate cuts or raise, the market will react appropriately either by surging higher or lower.
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