What is the best method of

analysis for forex trading?

By Ayton MacEachern | Updated May 16, 2018 — 2:00 PM EDT

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Forex analysis is used by retail forex day traders to determine buy or sell
decisions on currency pairs.

Forex analysis could be technical in nature, using resources such as charting

tools. It can also be fundamental in nature, using economic indicators and/or
news-based events. The day trader's currency trading system uses analysis to
determine buy or sell decisions when they point in the same direction.
Automated forex trading strategies that incorporate technical and fundamental
analysis are available for free, for a fee or can be developed by more tech-saavy
traders.

Types of Analysis Used in Forex

FUNDAMENTAL ANALYSIS
Fundamental analysis is often used to analyze changes in the forex market by
monitoring factors, such as interest rates, unemployment rates, gross domestic
product (GDP) and many other types of economic data that come out of
countries. For example, a trader conducting a fundamental analysis of the
EUR/USD currency pair would find information on the interest rates in
the Eurozone more useful than those in the U.S. Those traders would also want
to be on top of any significant news releases coming out of each Eurozone
country to gauge the relation to the health of their economies.

TECHNICAL ANALYSIS
Technical analysis comes in the form of both manual or automated systems.
Forex systems use past price movement to determine where a given currency
may be headed. A manual system typically means a trader is analyzing technical
indicators and interpreting that data into a buy or sell decision. An automated
trading analysis means that the trader is "teaching" the software to look for
certain signals and interpret them into executing buy or sell decisions. Where
automated analysis could have an advantage over its manual counterpart is that
it is intended to take the behavioral economics out of trading decisions.

Automated technical analysis and manual trading strategies are available for
purchase through the internet. However, it is important to note that there is no
such thing as the "holy grail" of trading systems in terms of success. If the
system was a fail-proof money maker, then the seller would not want to share it.
This is evidenced in how big financial firms keep their "black box" trading
programs under lock and key.

WEEKEND ANALYSIS
There are three basic reasons for doing a weekend analysis. The first reason is
that you want to establish a "big picture" view of a particular market in which you
are interested. Since the markets are closed and not in dynamic flux over the
weekend, you don't need to react to situations as they are unfolding.

Secondly, the analysis will help you to set up your trading plans for the coming
week. Weekend analysis is akin to an architect preparing a blueprint to construct
a building to ensure a smoother execution. Remember, shooting from the hip can
leave a hole in your pocket! Finally, a weekend analysis helps build a routine so
you can establish the necessary mindset for the upcoming week. (For further
reading, see "9 Tricks of the Successful Trader.")

Forex Analysis: The Bigger Picture

Analysis can seem like an ambiguous concept to a new forex trader. Therefore,
it's important to think critically about the tenets of analysis, which we've outlined
in four steps below.

1. UNDERSTAND THE DRIVERS.

The art of successful trading is partly due to an understanding of the current
relationships between markets and the reasons that these relationships exist. It is
important to understand causation, remembering that these relationships can and
do change over time.

For example, a stock market recovery could be explained by investors who are
anticipating an economic recovery. These investors believe that companies will
have improved earnings and, therefore, greater valuations in the future and it is a
good time to buy. However, speculation, based on a flood of liquidity, could be
fueling momentum and that good old greed is pushing prices higher until larger
players are on board so that the selling can begin.

Therefore the first questions to ask are: Why are these things happening? What
are the drivers behind the market actions?

2. CHART THE INDEXES.

It is helpful for a trader to chart the important indexes for each market on a longer
time frame. This exercise can help a trader to determine relationships between
markets and whether a movement in one market is inverse or in concert with the
other.

For example, in 2009, gold was being driven to record highs. Was this move in
response to the perception that paper money was decreasing in value so rapidly
that there was a need to return to the hard metal or was this the result of cheap
dollars fueling a commodities boom? The answer is that it could be both, or as
we discussed above, market movements driven by speculation.

3. IS THERE A CONSENSUS IN OTHER MARKETS?

We can gain a perspective of whether or not the markets are reaching a turning
point consensus by charting other instruments on the same weekly or monthly
basis. From there, we can take advantage of the consensus to enter a trade in an
instrument that will be affected by the turn. For example, if the USD/JPY currency
pair indicates an oversold position and that the BOJ could intervene to weaken
the yen, Japanese exports could be affected. However, a Japanese recovery is
likely to be impaired without any weakening of the yen. (For further reading,
see "The U.S. Dollar and the Yen: An Interesting Partnership.")
4. TO TRADE OR NOT TO TRADE
There is a much higher chance of a successful trade if one can find turning points
on the longer timeframes then switch down to a shorter time period to fine-tune
an entry. The first trade can be at the exact Fibonacci level or double bottom as
indicated on the longer term chart, and if this fails then a second opportunity will
often occur on a pullback or test of the support level.

Patience, discipline and preparation will set you apart from traders who simply
trade on the fly without any preparation or analysis of mulitple forex indicators.
(For more trading tips, read "The Most Reliable Indicator You've Never Heard
Of.")

The Bottom Line

There is no "best" method of analysis for forex trading between technical and
fundamental analysis. The most viable option for traders is dependent on their
timeframe and access to information, while it does not hurt to conduct a weekend
analysis when the markets are not in a constant state of fluctuation. For a short-
term trader with only delayed information to economic data, but real-time access
to quotes, technical analysis may be the preferred method. Alternatively, traders
that have access to up-to-the-minute news reports and economic data may
prefer fundamental analysis.

For more on this topic, see "Forex Trading Strategy."

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Forex Trading example
Forex trading allows you to speculate on price movements in the global foreign exchange
market. Currency values rise and fall in relation to each other and in response to national and
international economic, financial and political events.

When trading forex, you would buy a currency pair if you believed that the base currency will
strengthen against the counter currency. Alternatively, you would sell a currency pair if you
believed that the base currency will weaken in value against the counter currency.

You can choose to trade FX through CFDs, spot FX and spread bets.

Learn more about the type of FX trades available here.

Selling (going short) GBP/USD as a spread bet

Traders are bracing themselves for Brexit. You expect the pound to depreciate against the US
Dollar, i.e. the US Dollar will strengthen against the pound, and decide to sell (go short) £5 a
point at 1.22262.

Note: in this example the margin as well as the p&l are calculated in pounds.

The winning trade

You were right about your suspicions, and the Pound drops against the Dollar. The rate drops to
1.22045, at which point you close your trade, netting 108.5 in profit.

The losing trade

You market didn’t move as you expected, and instead Brexit has revitalized the Pound and
pushed it higher. The Pound climbs to 1.22489 before you decide to close your position.
Buying (going long) GBP / USD as a CFD trade
The jobs market in the US appears to be stalling and you expect the level on Non-farm Payrolls
to come in below analyst’s estimates.

You believe that the US dollar will weaken and the British pound will strengthen against the US
dollar, and decide to buy (go long) 1 CFD (per 0.0001) on GBP/USD at 1.2300.

Margin and Profit/Loss are calculated (and denominated) in the second, or counter currency of
the pair.

The winning trade

Good news, Non-farm Payrolls came in weaker than expected and the dollar slumped sending
GBP/USD higher. GBP/USD is now trading at 1.2380 / 1.2382 and you decide to sell to close at
1.2380.

You bought at 1.2300 and sold at 1.2380, a rise of 80 pts. This gives you a profit of $80

City Index automatically converts trading P&L into the client’s denominated account currency at
the prevailing market rate at the time that the trade is closed.
Losing trade

Let’s look at what would have happened if the actual non-farm payroll data had come in better-
than-expected, the US dollar would have strengthened against the pound, sending GBP/ USD
lower.

If GBP/USD fell and you sold to close at 1.2250 you would lose $50.

A sell trade (going short) on EUR / USD as a spot FX trade

Investors are concerned about the upcoming elections across Europe and you expect the euro to
fall against the US dollar. You decide to sell (go short) €20,000 at 1.0650.

In forex trading, the trade size is in units of the first, or base, currency in the pair

EUR/USD has a margin factor of 3.33%

The margin as well as the p&l are calculated in dollars, the counter currency of the pair.

Winning trade

The euro drops against the dollar as political event risk increases and you decide to buy €20,000
at 1.0570 to close your trade with a profit of $160.

City Index automatically converts trading P&L into the client’s denominated account currency at
the prevailing market rate at the time that the trade is closed.
Losing trade

Supposing a weaker dollar across the board pushes the euro up by 50 points and you buy to close
at 1.0700 you would have lost $100.

Note: in this example the margin as well as the p&l are calculated in pounds.

NEXT CHAPTER MARGIN AND LEVERAGE

FX Trading steps
1. Choose a currency pair
Decide which currency pair you wish to trade. With over 65 currency pairs to choose from,
picking a trading opportunity that’s right for you is important.
City Index’s technical and fundamental research tools can help you spot currency trading
opportunities to suit your trading style. We recommend that you take your time to
understand the amount of price volatility associated with the currency pair to help manage
your risk.

2. Decide on the type of FX trade

There are three ways to trade forex with City Index Spread Betting, CFD or Forex
Trading. Each has its particular stake size:

 In spread betting you trade pounds per point movement

 In CFD trading you trade a quantity of CFDs in the unit of the base currency
(currency on the left). For example if you trade GBP / USD your stake would be in
Pounds, while in USD / JPY your stake would be in US Dollars
 In Forex trading you buy lots, in the unit of the base currency (currency on the left)
 For example if you trade GBP / USD your stake would be in Pounds, while in USD /
JPY your stake would be in US Dollars (the minimum stake size is 1000)
3. Decide to buy or sell
Once you have picked a market, you need to know the current price it is trading at, which
you can do by bringing up an order ticket in the platform. All forex is quoted in terms of one
currency versus another. Each currency pair has a ‘base’ currency and a ‘quote’ currency.
The base currency is the currency on the left of the currency pair and the quote currency is
on the right. Put simply, when trading foreign currencies, you would:

BUY a currency pair if you believed that the base currency will strengthen against the quote
currency, or the quote currency will weaken against the base currency.

Your profits will rise in line with every increase in the exchange price.

Every fall in the exchange price below your open level, will net you a loss.

SELL a currency pair if you believed that the base currency will weaken in value against the
quote currency, or the quote currency will strengthen against the base currency.

Your profits will rise in line with each point the exchange price falls.

Every increase in the exchange price above your open level, will net you a loss.

Spread - FX pairs have two prices.

The first price is the sell price (known as the bid) and the second price is the buy price (also
known as the offer). The difference between the buy price and the sell price is known as
the spread, and is basically the cost of the trade.

4. Adding orders
An order is an instruction to automatically trade at a point in the future when prices reach a
specific level predetermined by you. You can utilise stop and limit orders to help ensure that
you lock in any profits and minimise your risk when your respective profit or loss risk targets
are reached.

While not compulsory, given the volatility in FX markets using and understanding risk
management tools such as stop loss orders is essential.

A stop loss order is an instruction to close out a trade at a price worse than the current
market level and, as the name suggests, is used to help minimise losses. There are two
types of stop loss orders - standard and guaranteed.
A standard stop loss order, once triggered, closes the trade at the best available price.
There is a risk therefore that the closing price could be different from the order level if
market prices gap.

A guaranteed stop loss however, for which a small premium is charged upon trigger,
guarantees to close your trade at the stop loss level you have determined, regardless of any
market gapping.

A limit order is an instruction to close out a trade at a price that is better than the current
market level and is used to help lock in price targets.

Standard stop losses and limit orders are free to place and can be implemented in the
dealing ticket when you first place your trade, and you can also attach orders to existing
open positions.

Learn more about risk management here.

5. Monitor and close your trade

Once open, your trade’s profit and loss will now fluctuate with each move in the market
price.

You can track market prices, see your unrealised profit/loss update in real time, attach
orders to open positions and add new trades or close existing trades from your computer or
app on your smartphone and tablet.

6. Closing your trade

When you are ready to close your trade, you simply need to do the opposite to the opening
trade. Supposing you bought 3 CFDs to open, you would sell 3 CFDs to close. By closing
the trade, your net open profit and loss will be realised and immediately reflected in your
account cash balance.

Please note that City Index Spread Betting and CFD accounts are FIFO - to read
moreabout this please visit our help and support section.

Forex trading examples

Carefully look through the Forex trading examples here to ensure you understand how forex
trading works.
What is fundamental analysis?
Unlike technical analysis, which looks purely at price action and trends, fundamental
analysis takes on a much more rigorous assessment of an asset, such as a commodity or
currency to build up a more holistic picture of its strengths and weaknesses.

Looking particularly at the forex markets, fundamental analysts look at key elements that
are likely to have a bearing on the strength or weakness of a particular currency, such as
economic data, political factors and even the impact of natural disasters.

A simple analogy illustrates how fundamental analysts work; in property investment, you
might buy a house on expectations that its price might rise in value because it is in a high-
growth area. A fundamental analyst however, would look at the house’s foundations,
insulation, history, previous tenants, the surrounding schools, nearby shopping centres and
scope for improvements in the surrounding area before deciding to invest.

Put simply, fundamental analysts use every piece of available data to help them gauge the
strength of a particular asset.

For example, fundamental analysts pay particular attention to the release of key economic
data and reports such as unemployment and GDP data, interest rate announcements and
production data to determine the future direction of a currency's price movement whilst
share traders would look at earnings reports.

Key factors of fundamental analysis

Company earnings
Company earnings form a crucial part of fundamentally analysing whether a current share
price is undervalued or overvalued.

Fundamental analysts can also get guidance on profit projections from earnings reports
while looking at key contributing elements to the bottom line, and then use this information
to ascertain whether a company could outperform or underperform in their future earnings.

Natural disasters
Natural disasters, such as flooding, hurricanes and tsunamis can have a major impact on
the fundamental strength and weakness of an asset.

For example, the 2010 tsunami in Japan had a debilitating impact on the region's
manufacturing sector, which caused significant disruption to the production of mobile
technology and automakers. At the same time, the tsunami also increased expensive
insurance claims which weighed on the balance sheets of major insurance firms.

Economic growth and output

The key indicator of economic growth is Gross Domestic Product (GDP), which calculates
the sum of goods and services produced within the country. It’s one of the most important
indicators of economic growth and output, which tells us about the economic strength and
performance of the country.

Inflation
Key indicator 1: Consumer Price Index (CPI) measures the change of the average price of
goods and services paid by consumers. It’s a major indicator adopted by governments for
inflation targets and has a significant impact on setting interest rates.

Key indicator 2: Producer Price Index (PPI) measures the changes in the price of goods and
services at the producers’ level.

Interest rates
Interest rates have a direct impact on currency rates. The demand on the currency with a
higher yielding interest rate is often greater than the one with a lower interest rate.

International trade
As the demand for goods and services from a particular country increases, demand for the
country’s currency also goes up. This means the value of the currency will appreciate (rise).

Political situation
Political crisis and uncertainty in a country often have a negative impact on the demand for
the currency. When a country is politically unstable, investors’ confidence in its economy
tends to decrease.

Fiscal policies
Fiscal policies, such as budget planning, government spending and taxation encourage or
discourage productivity and spending in the economy, and therefore have a major impact
on the currency markets.

Monetary policy
The monetary policy adopted by Central Banks has a big influence on the near-term
demand for currencies.

If, for example, the Bank of England adopts a hawkish monetary policy, this indicates that
interest rates are set to rise and may increase the demand for the pound sterling, which
could therefore appreciate as a result. (Hawks generally favour using relatively high interest
rates to help keep inflation in check.)
What is technical analysis?
Technical analysis refers to the use of charts generated by a trading platform or other
software to analyse the direction of markets and also possible entry and exit points for
trades.

Technical analysis is different from fundamental analysis: it involves looking purely at

market prices and patterns. Fundamental analysis involves any research into what is driving
the price of the market. The two can be combined or used independently of each other. At
each extreme, there are traders who solely use technical analysis and others who are
purely fundamental traders.

Finding short term trading opportunities within the financial markets is about interpreting the
current position of the market and then preparing yourself ahead of time for a potential
move in your favour. It is essentially about taking a risk and seeking a positive outcome
over a period of time. While it does not hold all the answers, technical analysis can be a
useful tool to assist in this area.

Technical analysis can be considered as a neutral tool which does not rely only on an
analyst’s forecast. Instead, technical analysts choose to focus on price patterns and timing.

Advantages of technical analysis

The advantages of technical analysis are that it can be applied to virtually any trading
instrument and in any timeframe. Technical analysis can be used to analyse anything from
stocks, commodities, interest rates or forex. You can also apply technical analysis from a
short term perspective to a longer term time frame. In fact it can be applied to a chart
ranging from minutes on an intra-day time frame to weekly or even monthly time frames.

It is important to understand that technical analysis can be used as a standalone method or

it can be incorporated with other methods such as fundamental analysis or market timing
methods.

Professional traders use technical analysis to create a set of clear rules and guidelines to
assist in the decision making process of when, where and how to enter and exit a trade. For
example, it can form part of your trading plan, establishing your rules for entering and
exiting trades.

Using popular technical Indicators and chart patterns, a trader can apply readily available
tools and techniques to find potential trading opportunities in the global financial markets to
assist in successful trading.

Why is technical analysis important?

Many traders and investors use technical analysis to inform them of the direction of
markets. Markets are not completely random and if you see a pattern emerging, the
chances are many others can too. This makes it almost a self-fulfilling trend. Traders and
investors help to create the patterns we see in market prices.

City Index and technical analysis

You can see some of the most popular charts and measurements used by technical
analysts on our site. Not only will this help you to interpret what analysts are talking about,
but also to recognise patterns that could impact your own trading decisions.