In many ways, the currency, currency, or currency market is no different than any other market, and prices are largely determined by simple laws of supply and supply. If a currency is in demand, its price will rise, but if demand is low, its price will fall.
This principle is quite simple to understand and you might think that against this background it should be quite easy to predict the movement of currency prices. Unfortunately, this is not the case.
By the mid-1980s, most marketers relied on a method known as fundamental analysis to predict market movement. Today, however, an increasing number of traders have diverted from fundamental analysis in favor of technical analysis, although there are still a significant number of traders left with fundamental analysis or who use it to support the results of their technical analysis.
Let's look briefly at each of these two analytical methods.
The principle based on fundamental analysis is that changes in the political, economic and social factors that dictate demand and supply and market movements can be predicted by examining these factors.
The fundamental analysis therefore looks at political events and economic data such as inflation, interest rates and trade data, as well as social data such as employment rates. Historical data is then used as a basis for predicting movements in the light of current figures. In other words, an analysis of, for example, the effect that rising or falling interest rates have had on currency prices in the past is used to predict the effect that interest rates will have today on or off.
The biggest problem with fundamental analysis is the huge amount of data that needs to be analyzed and the fact that there is a great deal of disagreement as to which data is important and which is not. In some neighborhoods, it is also felt that as the world has changed dramatically in recent years, many of the factors that may have influenced currency prices in the past may not necessarily have the same effect today.
Perhaps one area of common agreement is that a country's balance of payments analysis is crucial to the success of a fundamental analysis. The balance of payments is important because it reflects the flow of currency in and out of the country and a situation where money enters a country faster than flowing or vice versa will clearly affect currency prices. Analyzing how prices will be affected, of course, is something that has been heavily discussed by fundamental analysts.
The principle behind the technical analysis is simply that although the political, economic and social factors really govern the market, there is no need to study or even understand it, because whatever factors you choose have emerged again and again in the past and their influence can be seen simply by studying the historical pattern of currency movements.
Accordingly, the main tool of a technical analyzer is a chart, or rather a series of charts, that provides graphical representation of the market over time. Examining such charts will show that there are clear trends and patterns of price movements, and thus expanding the current chart based on past patterns will show the direction in which the currency will move.
As with fundamental analysis, there is a wide range of different charting tools and widespread disagreements about which they are valuable and of little or no benefit.
Deciding which method to adopt is not easy, although most novice marketers today choose to follow a technical analysis. This may be because they firmly believe that it is the better of the two methods, but in most cases it is likely because the acquisition of fundamental analysis skills takes a long time and involves a steep learning curve and because this is the direction, where the Forex trade is headed.