Several methods are available for analyzing the forex market with the intention of identifying profitable trading opportunities. And, combining the different approaches has been proved to be more beneficial in generating profits.
The three main types of analysis are:
- Fundamental analysis
- Technical analysis
- Sentiment analysis
Some traders prefer to concentrate on a single type of analysis because it makes it easier to master thoroughly one section of the forex market. However, taking a combined approach eliminates many of the weaknesses of concentrating on one method and increases the chances of identifying profitable trades.
Truth be told, to perform a comprehensive market analysis, you need all the three approaches. Just like a three-legged stool requires all the three legs to be stable, forex trading also needs all the three types of analysis to be profitable.
If you focus only on one technique and ignore the others, your analysis could be weak and may lead to losses. A weakness of one technique of analysis can easily be surmounted by considering another type of analysis.
So, how do you combine the three types of forex analysis?
Let’s start by talking about each of the different approaches.
This type of analysis focuses on the various economic factors that affect the value of currencies. Some of the economic fundamentals include inflation rates, interest rates, political issues, unemployment rate, and Gross Domestic Product.
Traders using fundamental analysis to identify trade opportunities, called fundamentalists, believe that the underlying macroeconomic condition is reflected in the value of the currency.
As such, a country with a strong economy will have a stronger currency than a country with a weaker economy. Fundamentalists usually analyze a country’s economic outlook and determine whether its currency will appreciate or depreciate.
These traders often look at major economic announcements and reports to assist them in gauging the value of the associated currency. The important economic events are usually reported in economic calendars. For example, the ForexPeaceArmy website has a comprehensive economic news calendar you can use in doing fundamental analysis.
Before an economic announcement is released, leading economists from around the world usually come up with a consensus designating the extent of expectation for that report. Consequently, the upcoming economic report will be weighed against the consensus to determine its level of impact on the forex market.
The release of the report is often categorized as follows:
- As expected—the released statement was according to the expectations.
- Better-than-expected—the released statement was better than the expectations.
- Worse-than-expected—the released statement was worse than the expectations.
The interpretation of whether the announced report is above or below the consensus level usually leads to increased volatility in the market, as traders swiftly open and close positions. Often, broader degrees of variation between the consensus and the actual released report lead to extensive movements in the forex market.
If an economic report is better-than-expected, it indicates the economic outlook of the country is positive, which could lead to the the associated currency gaining value relative other currencies.
Conversely, if a report is worse-than-expected, it signifies the economic outlook of the country is negative, which could cause the associated currency to depreciate.
Most fundamental traders believe that a report at or nearly at consensus level will usually just result in a neutral effect.