Although the Forex market is driven very much by supply and demand, predicting either is no easy matter. Today's analysts can however be divided into two broad camps - fundamental analysts and technical analysts.
Movements in the Forex market are based upon the simple law of supply and demand. When there is a demand for a particular currency its price will rise and when there is an excessive supply of a currency its price will fall. Despite this seemingly simple principle, predicting movements in foreign exchange prices is not at all easy.
Today there are two main methods used to predict movements in the Forex market - fundamental analysis, which dominated the Forex market until the mid 1980s, and technical analysis, which has become increasingly popular in recent years with the arrival of new technology providing the necessary analytical tools.
Fundamental Analysis
Traders who base their predictions on fundamental analysis focus their attention on the economic, political and social factors which drive supply and demand. Their analysis is based upon such things as interest rates, inflation, unemployment and economic growth rates and from these they make an assessment of a currency's present performance and predict its future movement.
The biggest problem with fundamental analysis is that it requires the trader to constantly keep abreast of events and to analyze a huge amount of data. There is also considerable debate about just what data should be included in this analysis and just how much weight should be given to each of the various indicators.
All analysts would however agree that central to fundamental analysis is a country's balance of payments which shows the flow of money in and out of a country. In theory at least, a balance of payments of zero would produce a static price and a balance of payments surplus or deficit would cause the currency to move. For example, a balance of payments deficit indicates that money is leaving a country faster than it is coming in and would normally result in a fall in the value of the currency.
Technical Analysis
The technical analyst studies price movements and uses historical price data to predict future prices.
There are two principles to technical analysis. The first is that history repeats itself and that prices will move today according to patterns which have been well established over time. The second is that it is not necessary to study current market information to predict movements in the market as this will already be reflected in currency prices. In other words, it is the movement in the price itself which needs to be studied to predict the direction in which it is heading.
The primary tool of the technical analyst is a chart which presents a graphic representation of the market over time and allows trends to be spotted in the pattern of price movements. A wide variety of different charting techniques are used including such things as moving averages, candlestick charts, oscillators, Fibonacci retracement levels, Bollinger bands and others.
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