A brief review of fundamental and technical analysis

The careful and thorough forex market analysis is a challenging but very rewarding task. It is exactly the analysis which draws the dividing line between sophisticated trading and gambling. The two main methods used independently for building successful market strategies are outlined below.

Fundamental Analysis is the application of macroeconomic theory to markets, to provide forecasts on future trends, with four fundamental forces driving markets to form such trends:

• Balance of trade: the difference between exports and imports values. It describes the flows of incoming and outgoing currencies, positive when exports outweigh imports, and vice versa. In the latter case a deficit is formed, and the country sells a lot of its currency to pay for imports. As a result the country’s currency is devaluated. The improvement in the balance of trade results in appreciation of the local currency against other currencies.
• Interest rates: international capital flows target countries offering high returns, provided that inflation levels are low. Therefore, money goes where real interest rates are high. It is handy to discuss the concept of real interest rate here. The latter is equal to nominal interest rate minus inflation.
• Relative inflation rates: rates of price growth; higher rates result in a weakening currency.
• Expectations and speculation: expectations drive markets! Expectations related to future inflation rate, economic growth rate, employment and unemployment can greatly impact exchange rates.

The driving forces outlined above act simultaneously, but the combined effect is difficult to assess, so technical analysis can help for such assessment.

Technical Analysis

The task of technical analysis is the exploration of a financial asset’s dynamics, rate, price change amplitude, on the basis of graphical representations of price movements.

The major tools of technical analysis used for identifying current market trends are the following:

• Charts: the most common chart types are line charts, bar charts and candlestick charts. Line charts present the price dynamics of financial instruments in the course of time; in line charting, closing prices for a given time interval are connected by the means of a line. Bar charts present price movement by bars; they show the open, close, high, and low price for a specific interval. Candlestick charts are a type of bar chart, in which OHLC prices are shown as “candlesticks” with wicks.
• Support and resistance levels: the extremes at which changes in price movement occurs. Resistance levels are above current market prices, and support levels below them. In support levels, interest in purchasing prevails over interest in selling. Static support zones are associated with highest significance levels with unchanging value; in dynamic support, the value increases continuously. Resistance levels are characterized by reluctance by most market participants to pay over a certain price level. Static resistance includes extremes preceding downward movements, and dynamic resistance includes the highs in a downward movement, with gradually decreasing value.
• Trends: the general direction of financial asset prices within a time frame. There is an imbalance between supply and demand forces, with uptrends when buyers dominate, and downtrends when sellers prevail.
• Range: formed by price fluctuations when no higher than previous maximum or lower than previous minimum prices occur. Balancing supply and demand forces yield price consolidation. Range follows trend to complete the market cycle.
• Indicators: technical analysis has an arsenal of thousands of indicators which show different aspects of the price movement and facilitate the decision making process of a trader. It is important to mention here the following two main groups of indicators:

1. Moving averages: highlight the prevalence of a trend by smoothing out the impact of the extreme values over a given period.
2. Stochastic oscillators: momentary indicators which show when buying or selling is recommended. Oscillators also assist in making a judgment when a currency pair is oversold or overbought.