In Forex Trading, there are two basic approaches – Fundamental Analysis where analysts will concentrate on the underlying causes of price movements, and Technical Analysis where the technical chartist studies the markets actual price movements.
Fundamental analyst focus on various macroeconomic indicators such as Interest Rates, Growth Rates, and Unemployment rates, Trade Balances, Gross Domestic Product (GDP), and Inflation etc. There are many varied theories on how a currency should be valued so beginners should take note that there is no one single set of rules to successfully trade Forex using fundamental analysis.
Technical analysts use the data from historical prices to forecast the direction of future price movements. Technicals analysis is based on the theory that all current market information is already reflected in the price and that studying price action alone is all that is necessary to trade the market.
Some popular methods of technical analysis include, Chart Patterns, Japanese Candlestick Patterns, Fibonacci Retracement, Support and Resistance Levels, Pivot points, Trend lines and Elliott wave theory. Technical Indicators which utilize mathematical or quantitative tools are Moving Averages, Bollinger Bands, Average True Range, Stochastic Oscillators, Fibonacci Retracements, Commodity Channel Index, Convergence and Divergence of Moving Averages (MACD) and Relative Strength Index (RSI).
After understanding these two widely known methods of analysis available, you could be more or less able to tell which methodology suits you most. If you are the type of person that is very interested in finance, fundamental analysis may be your forte.
In Forex trading, traders tend to rely more on technical analysis to make informed decision on future price movement. It is very difficult to keep up to date with the volume of information that would be required to keep abreast of to trade forex using fundamentals analysis.
Most seasoned traders after years of trading tend to develop their own forex trading system or methodology. The system could be a combination of a few technical indicators which they have become very comfortable with using. It is only when a trader is very comfortable with his system that he will begin trade it wholeheartedly and confidently.
For others who are less technical, they may decide to trade based on someone else’s system. Regardless of whatever approaches you use – be it fundamental analysis or technical analysis, the system or method must be profitable and nothing else matters.
Many traders may think that the best way to find out whether a forex trading system or method is profitable is through back testing. However, back testing has its disadvantage in that it can never fully duplicate current live market conditions. What is obvious in an historical setup may not be so obvious in real time trading.
An alternative means of testing a system is by forward testing your trading system in real-time with a practice trading account. Forward testing will give you a more reliable and clearer understanding of what your trading system is really capable of. Free forex trading accounts are widely available and the trades are just like trading in a real account, so they are an excellent way to fully evaluate the profitability of a system.