Examining the Three Types of Market Analysis: Technical, Fundamental and Sentiment
As a budding currency trader, there are a variety of different methods at your disposal for assessing the state of the global markets depending on which perspective — be it fiscal, geopolitical or even sentimental — you most wish to focus on.
Despite their different processes and considerations, all of these analytical frameworks share one common goal — namely, accurately predicting how the markets are going to move in the near term so you can plan your trades accordingly and not miss out on an opportune moment!
In order to make the best returns possible, speculators should start by familiarising themselves with each of the main three types of analyses, as they’re perhaps the most critical and can be used in tandem with each other to make wiser trades; though as you’ve no doubt learned by now, nothing’s ever for certain in forex!
What is Technical Analysis?
Technical analysis is primarily focused on price movement, hinging on the principle that all the information you could possibly need to judge your next move is contained within the current price of the instrument itself.
After all — so the theory goes — if the current market conditions happen to be either notably favourable or unfavourable, then the iron laws of supply and demand will ensure this is conveyed via a change in price.
In essence, traders conducting technical analyses will assess the previous price fluctuations of a particular security (together with current market conditions) to try and predict where the price is likely headed in the near future before committing to either buying or selling.
Why is Technical Analysis Effective?
Speculators often favour technical analysis because certain market trends tend to hold true on different instruments over time. This means that if a certain price has turned out to be significant in the past — for example, either as a support or resistance level — then there’s a good chance that, barring any overriding external factors, the market will behave similarly the next time it is met.
Technical analysts, therefore, spend a great deal of time looking to match current market behaviours to historical trends to ‘get ahead of the curve’, so to speak, with future movements. For this reason, they often make heavy use of forex charts as a visual representation of key resistance and support points — alongside technical terms such as ‘pivot points’, ‘Fibonacci levels’ and ‘Bollinger bands’ to describe their predictions in minute detail, which we’ll get to in a future article.
Interestingly, because technical analysis is such a commonly relied-upon method of examining the markets, these predictions can often become self-fulfilling as identifiable trends are translated into real-life activity thanks to a global community of keen-eyed investors acting on their ideas.
However, it should equally be noted that these analyses tend to be very subjective; just because one trader is convinced there’s a familiar pattern emerging doesn’t guarantee another will spot the same trend, or be in agreement over its significance!
Further reading: https://admiralmarkets.com/education/articles/forex-analysis/introduction-to-forex-technical-analysis
What is Fundamental Analysis?
Unlike technical analysis, fundamental analysis takes a more holistic approach to assessing market movements.
Going beyond simply price fluctuations, fundamental analysts look to incorporate pertinent economic, political and social considerations that could impact the perceived value of the instrument in question into their predictions.
While this sounds ideal on paper, the obvious concern is: what criteria do we take to be significant at any given time? There are endless economic data releases, national elections, social movements and other political goings-on around the globe every day, and any number of these could have a small (sometimes even imperceptible) knock-on effect on the financial markets (c.f. ‘the butterfly effect’).
Because of this dizzying amount of information, there are several key areas analysts tend to focus on, which we’ll discuss below.
What Issues Do Fundamental Analysts Focus On?
Key barometers that are often used in fundamental analyses include unemployment rates, interest rates, gross domestic product (GDP) figures and other economic data releases from the respective country of the specific currency you’re interested in.
As a general rule, the more a country’s economy thrives, the more attractive it is to investors and so more people end up purchasing its respective currency to obtain those assets; this may, in turn, lead to interest rates being raised to keep growth and inflation at manageable levels.
For instance, if you’re interested in trading on the NZD/USD pair (colloquially the ‘Kiwi’), you’d pay specific attention to New Zealand’s current economic climate and any changes to interest rates announced by the Reserve Bank of New Zealand — which is known to take a hands-on approach to managing inflation through adapting monetary policy — and, to a lesser extent, the US Federal Reserve.
Additionally in this specific example, traders would also probably want to keep their eye on export statistics and the price of milk products, as these are often a reliable indicator of the direction of farming-focused New Zealand’s economic fortunes, with the NZD often appreciating or depreciating in tandem (and, crucially, in the opposite direction of the USD).
Because of the myriad nuances and factors unique to each country, traders should do their homework on the instruments they’re especially interested in trading to identify the most salient indicators as to their likely market movement.
Further reading: https://www.investopedia.com/articles/trading/04/031704.asp
What is Sentiment Analysis?
As the name suggests, sentiment analysis is the practice of attempting to judge the overall mood of the trading community towards the state of a given market (i.e. the ‘market sentiment’).
This is necessary because, despite all the information out there regarding the current movement of the economy — as well as all the geopolitics that may be exerting pressure behind the scenes — it’s evidently the case that not all traders behave the same way; some will develop bearish attitudes towards a market whilst others will become more bullish over the exact same period.
Every single trader — whether they’re a novice beginner or Warren Buffett himself — has their own thoughts on what’s happening in the markets, which are subsequently reflected in their trading decisions. What’s more, as one humble retail trader among several million, you’ll never be able to single-handedly move the market in your favour, so other individuals’ actions are invariably going to affect the outcome of your trades.
Accordingly, it’s wise to take a step back and gauge your fellow investors’ feelings in a broader sense — think ‘overall, are speculators leaning towards buying or selling this instrument at this moment in time?’ — and let this inform into your own choices.
How Should Market Sentiment Affect My Strategy?
Once you’ve discerned whether the market has either a bullish or bearish sentiment (and to what degree that seems to be the case), it’s solely up to you what you do with this information.
Practically speaking, if you’re sure the USD is likely to appreciate but the market seems bearish for the most part, do you follow then the wisdom of the crowd and sell or forge your own path and buy — with all the risk, and possible reward, that implies?
This is part of what makes forex so exciting, but also what causes so many newbies to crash and burn straight out of the gate; gathering information is one thing, knowing how best to react to it is something that is only truly learned with time, trial and error!
Further reading: https://www.learntotrade.co.uk/sentiment-analysis-what-why/
Which Type of Analysis Should I Use?
Whilst each type of analysis examined above has its own merits, they also have their own limitations and drawbacks — meaning that by far the most effective strategy is to include a little bit of each into your trading plans.
Think of a tricycle: each wheel is fundamental in making the entire vehicle move smoothly; if you remove just one, the tricycle is nowhere near as effective at its job (in our case, providing you with a clear and informed picture of the forex markets).
The last thing you want is to focus too heavily on a particular paradigm — and investing your precious time and funds accordingly — only to be blindsided by a factor you hadn’t even discovered!
Though it may seem like more work — even a little daunting at first — a nuanced, well-balanced analysis regimen covering all bases is far more likely to deliver the returns (i.e. profits) you’re looking for that simply sticking to your favourite predictive model forever. Remember, fortune helps those that help themselves!
Use at your own risk disclaimer:
The content contained herein does not construe any form of advice and the user must not take this as such. We do not accept any liability for the direct or indirect usage of the content held in this article. We strongly advise that you obtain independent financial, legal and tax advice before proceeding with any currency or spot metals trades.
