Which Type of Analysis is Best?

Ahhhh, the million dollar question....

Throughout your journey as an aspiring forex trader you will find strong advocates for each type of analysis. Do not be fooled by these one-sided extremists! One is not better than the other...they are all just different ways to look at the market.

At the end of the day, you should trade based on the type of analysis you are most comfortable and profitable with.

To recap, technical analysis is the study of price movement on the charts while fundamental analysis takes a look at how the country's economy is doing.

Market sentiment analysis determines whether the market is bullish or bearish on the current or future fundamental outlook.

Fundamental factors shape sentiment, while technical analysis helps us visualize that sentiment and apply a framework for our trades.

Those three work hand-in-hand-in-hand to help you come up with good trade ideas. All the historical price action and economic figures are there - all you have to do is put on your thinking cap and put those analytical skills to the test!

Let me pull out that three-legged stool again just to emphasize the importance of all three types of analysis.

Take out one or two legs of the stool and it's going to be shaky!

In order to become a true forex master you will need to know how to effectively use these three types of analysis.

Don't believe us?

Let us give you an example of how focusing on only one type of analysis can turn into a disaster.

• Let's say that you're looking at your charts and you find a good trading opportunity.

You get all excited thinking about the money that's going to be raining down from the sky.

You say to yourself, "Man, I've never seen a more perfect trading opportunity in GBP/USD. I love my charts. Mwah. Now show me the money!"

• You then proceed to buy GBP/USD with a big fat smile on your face (the kind where all your teeth are showing).
• But wait! All of a sudden the trade makes a 100 pip move in the OTHER DIRECTION! Little did you know, one of the major banks in London filed for bankruptcy! Suddenly, everyone's sentiment towards Britain's market turns sour and everyone trades in the opposite direction!
• Your big fat smile turns into mush and you start getting angry at your charts. You throw your computer on the ground and begin to pulverize it. You just lost a bunch of money, and now your computer is broken into a billion pieces.

And it's all because you completely ignored fundamental analysis and sentimental analysis.

(Note: This was not based on a real story. This did not happen to us. We were never this naive. We were always smart traders.... From the overused sarcasm, we think you get the picture.)

Ok, ok, so the story was a little over-dramatized, but you get the point.

Remember how your mother used to tell you as a kid that too much of anything is never good?

Well you might've thought that was just hogwash back then but in forex, the same applies when deciding which type of analysis to use.

Don't rely on just one.

Instead, you must learn to balance the use of all of them. It is only then that you can really get the most out of your trading.

 Where do we go from here?

Now that you're done with Kindergarten and learned a little bit about each type of analysis, it's time to delve much deeper! Here's what's in store for the next few years of your life...

We're kidding, we're kidding! We're talking about the next few school years in the School of Pipsology.
Grade school will be all about basic technical analysis tools.
You'll learn all about the dynamics behind price action, such as support and resistance levels, candlestick formations, and common chart patterns. You'll experiment with leading and lagging indicators and discover how to use them in coming up with trade ideas. Sounds pretty exciting, doesn't it?
The remaining years of middle school and high school are devoted to studying more technical analysis tools.
We'll take a look at the more advanced tools also such as pivot points, divergences, Elliott Wave Theory, and Gartley patterns. Sounds fancy? It's because they are! Bet you can't wait to get started on those!
College will be a bit more complicated since you'll be tackling both fundamental and market sentiment analysis at the same time. Talk about hitting two stones with one bird! You're the bird and the stones are... well, you get the point.
A couple of reasons why we're putting fundamental and market sentiment analysis together:

• By the time you reach college, you'll be so hooked on learning more about forex that one lesson simply won't be enough.
• It is hard to draw the line between fundamental analysis and market sentiment analysis.

As we mentioned earlier, fundamental factors are mostly responsible for shaping market sentiment. Those two types of analysis would take up both freshman and sophomore year of college.

What is Technical Analysis?

Technical analysis attempts to forecast future price movements by examining past market data.

Most traders use technical analysis to get a "big picture" on an investment's price history. Even fundamental traders will glance at a chart to see if they're buying at a fair price, selling at a cyclical top or entering a choppy, sideways market. 

Technical analysts make a few key assumptions:

• All market fundamentals are reflected in price data. Moods, differing opinions, and other market fundamentals need not be studied.
• History repeats itself in regular, fairly predictable patterns. These patterns, generated by price movements, are called signals. A technical analyst's goal is to uncover a current market's signals by examining past market signals.
• Prices move in trends. Technical analysts believe price fluctuations are not random and unpredictable. Once an up, down or sideways trend has been established, it usually will continue for a period.

Get in and get out - at the right time 

Technical analysis can add discipline and minimise emotion in your trading plan. It can be hard to screen out fundamental impressions and stick with your entry and exit points as planned, but, technical analysis helps you see your trading plan more objectively and dispassionately.

Technical analysis can add discipline and minimise emotion in your trading plan. It can be hard to screen out fundamental impressions and stick with your entry and exit points as planned. While no system is perfect, technical analysis helps you see your trading plan through more objectively and dispassionately. 

Price chart types 

Bar charts

The most common type of chart showing price action. Each bar represents a period of time - a "period" as short as 1 minute or as long as several years. Over time, bar charts show distinct price patterns.

Candlestick Charts

Instead of a simple bar, each candlestick shows the high, low, opening and closing price for that period of time it represents. Candlestick patterns provide greater visual detail as they develop.

Point & Figure Charts

Point & figure patterns resemble bar chart patterns, except Xs and Os are used to mark changes in price direction. Point & figure charts make no use of time scale to associate a certain day with a certain price action. 

Technical Indicator Types

Trend

Trend indicators smooth price data out, so that a persistent up, down or sideways trend can be easily seen. (Examples: moving averages, trend lines)

Strength

Strength indicators describe the intensity of market opinion on a certain price by examining the market positions taken by various market participants. Volume or open interest are the basic ingredients of strength indicators.

Volatility

"Volatility" refers to the magnitude of day-to-day price fluctuations, whatever their directional trend. Changes in volatility tend to anticipate changes in prices. (Example: Bollinger Bands)

Cycle

Cycle indicators indicate repeating market patterns from recurrent events such as seasons or elections. Cycle indicators determine the timing of a particular market pattern. (Example: Elliott Wave)

Support/Resistance

Support and resistance describes the price levels where markets repeatedly rise or fall and then reverse. This phenomenon is attributed to basic supply and demand. (Example: Trend Lines)

Momentum

Momentum indicators determine the strength or weakness of a trend as it progresses over time. Momentum is highest when a trend starts and lowest when the trend changes.

When price and momentum diverge, it suggests weakness. If price extremes occur with weak momentum, it signals an end of movement in that direction. If momentum is trending strongly and prices are flat, it signals a potential change in price direction. (Example: Stochastic, MACD, RSI)

Technical Analysis

Technical analysis is the framework in which traders study price movement.
The theory is that a person can look at historical price movements and determine the current trading conditions and potential price movement.
The main evidence for using technical analysis is that, theoretically, all current market information is reflected in price. If price reflects all the information that is out there, then price action is all one would really need to make a trade.
Now, have you ever heard the old adage, "History tends to repeat itself"?
Well, that's basically what technical analysis is all about! If a price level held as a key support or resistance in the past, traders will keep an eye out for it and base their trades around that historical price level.

 

Technical analysts look for similar patterns that have formed in the past, and will form trade ideas believing that price will act the same way that it did before.


In the world of trading, when someone says technical analysis, the first thing that comes to mind is a chart. Technical analysts use charts because they are the easiest way to visualize historical data!
You can look at past data to help you spot trends and patterns which could help you find some great trading opportunities.
What's more is that with all the traders who rely on technical analysis out there, these price patterns and indicator signals tend to become self-fulfilling.
As more and more traders look for certain price levels and chart patterns, the more likely that these patterns will manifest themselves in the markets.
 You should know though that technical analysis is VERY subjective.
Just because Ralph and Joseph are looking at the exact same chart setup or indicators doesn't mean that they will come up with the same idea of where price may be headed.
The important thing is that you understand the concepts under technical analysis so you won't get nosebleeds whenever somebody starts talking about Fibonacci, Bollinger bands, or pivot points.