There are two types of analysis used in Forex trading, fundamental analysis and technical analysis. Fundamental analysis examines current political and economic events in order to predict movements in currencies, while technical analysis uses historical economic data to predict movements in the Forex market.
There are three underlying assumptions to technical analysis:
1. Movements in price are the result of a combination of all the forces is in the market. While currency prices can be affected by all sorts of things including political events, economic conditions, supply and demand and even the weather, technical analysis is not concerned with the reasons for movements in the market but is solely concerned with the movements themselves.
2. Currency prices follow trends. Over the years a number of market patterns have been recognized and technical analysis assumes that these have predictable consequences.
3. Movements in price follow historical trends. Forex data has been collected from more than 100 years and, over time, a number of patterns have emerged. These patterns are indicative of human psychology and the way in which people react to certain circumstances.
Although most Forex traders will use fundamental analysis to support their trading strategy, they will also rely heavily on technical analysis. The major problem with fundamental analysis is that it requires a detailed knowledge of the political and economic conditions of a large number of countries and for most traders, this is simply impractical. Technical analysis, on the other hand, can be applied across many different markets and currencies at the same time.
If you are new to Forex trading, then you may well find the complexity of technical analysis off-putting and wonder if it is really necessary. As with almost any form of investment, you must have a strategy for trading and that strategy must be based upon a prediction of movements in the market. Technical analysis has shown itself over time to be a sound tool for predicting such movements and is fairly accurate. Nothing of course will provide one hundred percent accuracy and currency prices are affected by a variety of different factors. It is for this reason that, while many traders use technical analysis, they also back up their trading strategy with fundamental analysis.
Every Forex broker will provide access to a range of different tools used for technical analysis and most of these tools, which will have the ability to update in real time, will generally be made available free of charge with some additional professional analytical tools being provided for a fee.
Before you start Forex trading it is a good idea to acquaint yourself with market behavior by following Forex charts for a period of time and by studying the movements and gaining an understanding of trends. Many brokers will provide training accounts just for this purpose, allowing you to trade on paper rather than with real money.
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