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Forex-Forecasting
This article provides insight into the two major methods of
analysis used to forecast the behavior of the Forex market.
Technical analysis and fundamental analysis differ greatly,
but both can be useful forecast tools for the Forex trader.
They have the same goal - to predict a price or movement. The
technician studies the effect while the fundamentalist studies
the cause of market movement. Many successful traders combine
a mixture of both approaches for superior results. |
Technical analysis
Technical analysis is a method of predicting price movements and future
market trends by studying charts of past market action. Technical
analysis is concerned with what has actually happened in the market,
rather than what should happen and takes into account the price of
instruments and the volume of trading, and creates charts from that
data to use as the primary tool. One major advantage of technical
analysis is that experienced analysts can follow many markets and
market instruments simultaneously.
Technical analysis is built on three essential principles:
1. Market action discounts everything! This means that the actual
price is a reflection of everything that is known to the market
that could affect it, for example, supply and demand, political
factors and market sentiment. However, the pure technical analyst
is only concerned with price movements, not with the reasons for
any changes.
2. Prices move in trends Technical analysis is used to identify
patterns of market behavior that have long been recognized as significant.
For many given patterns there is a high probability that they will
produce the expected results. Also, there are recognized patterns
that repeat themselves on a consistent basis.
3. History repeats itself Forex chart patterns have been recognized
and categorized for over 100 years and the manner in which many
patterns are repeated leads to the conclusion that human psychology
changes little over time.
Forex charts are based on market action involving price. There
are five categories in Forex technical analysis theory:
Indicators (oscillators, e.g.: Relative Strength Index (RSI)
Number theory (Fibonacci numbers, Gann numbers)
Waves (Elliott wave theory)
Gaps (high-low, open-closing)
Trends (following moving average).
Some major technical analysis tools are described below:
Relative Strength Index (RSI):
The RSI measures the ratio of up-moves to down-moves and normalizes
the calculation so that the index is expressed in a range of 0-100.
If the RSI is 70 or greater, then the instrument is assumed to be
overbought (a situation in which prices have risen more than market
expectations). An RSI of 30 or less is taken as a signal that the
instrument may be oversold (a situation in which prices have fallen
more than the market expectations).
Stochastic oscillator:
This is used to indicate overbought/oversold conditions on a scale
of 0-100%. The indicator is based on the observation that in a strong
up trend, period closing prices tend to concentrate in the higher
part of the period's range. Conversely, as prices fall in a strong
down trend, closing prices tend to be near to the extreme low of
the period range. Stochastic calculations produce two lines, %K
and %D that are used to indicate overbought/oversold areas of a
chart. Divergence between the stochastic lines and the price action
of the underlying instrument gives a powerful trading signal.
Moving Average Convergence Divergence (MACD):
This indicator involves plotting two momentum lines. The MACD line
is the difference between two exponential moving averages and the
signal or trigger line, which is an exponential moving average of
the difference. If the MACD and trigger lines cross, then this is
taken as a signal that a change in the trend is likely.
Number theory:
Fibonacci numbers: The Fibonacci number sequence (1,1,2,3,5,8,13,21,34...)
is constructed by adding the first two numbers to arrive at the
third. The ratio of any number to the next larger number is 62%,
which is a popular Fibonacci retracement number. The inverse of
62%, which is 38%, is also used as a Fibonacci retracement number.
Gann numbers:
W.D. Gann was a stock and a commodity trader working in the '50s
who reputedly made over million in the markets. He made his fortune
using methods that he developed for trading instruments based on
relationships between price movement and time, known as time/price
equivalents. There is no easy explanation for Gann's methods, but
in essence he used angles in charts to determine support and resistance
areas and predict the times of future trend changes. He also used
lines in charts to predict support and resistance areas.
Waves
Elliott wave theory: The Elliott wave theory is an approach to market
analysis that is based on repetitive wave patterns and the Fibonacci
number sequence. An ideal Elliott wave patterns shows a five-wave
advance followed by a three-wave decline.
Gaps
Gaps are spaces left on the bar chart where no trading has taken
place. An up gap is formed when the lowest price on a trading day
is higher than the highest high of the previous day. A down gap
is formed when the highest price of the day is lower than the lowest
price of the prior day. An up gap is usually a sign of market strength,
while a down gap is a sign of market weakness. A breakaway gap is
a price gap that forms on the completion of an important price pattern.
It usually signals the beginning of an important price move. A runaway
gap is a price gap that usually occurs around the mid-point of an
important market trend. For that reason, it is also called a measuring
gap. An exhaustion gap is a price gap that occurs at the end of
an important trend and signals that the trend is ending.
Trends
A trend refers to the direction of prices. Rising peaks and troughs
constitute an up trend; falling peaks and troughs constitute a downtrend
that determines the steepness of the current trend. The breaking
of a trend line usually signals a trend reversal. Horizontal peaks
and troughs characterize a trading range.
Moving averages are used to smooth price information in order to
confirm trends and support and resistance levels. They are also
useful in deciding on a trading strategy, particularly in futures
trading or a market with a strong up or down trend.
The most common technical tools:
Coppock Curve is an investment tool used in technical analysis
for predicting bear market lows.
DMI (Directional Movement Indicator) is a popular technical indicator
used to determine whether or not a currency pair is trending.
Unlike the fundamental analyst, the technical analyst is not much
concerned with any of the "bigger picture" factors affecting
the market, but concentrates on the activity of that instrument's
market.
Fundamental analysis
Fundamental analysis is a method of forecasting the future price
movements of a financial instrument based on economic, political,
environmental and other relevant factors and statistics that will
affect the basic supply and demand of whatever underlies the financial
instrument. In practice, many market players use technical analysis
in conjunction with fundamental analysis to determine their trading
strategy. Fundamental analysis focuses on what ought to happen in
a market. Factors involved in price analysis: Supply and demand,
seasonal cycles, weather and government policy.
Fundamental analysis is a macro or strategic assessment of where
a currency should be trading based on any criteria but the movement
of the currency's price itself. These criteria often include the
economic condition of the country that the currency represents,
monetary policy, and other "fundamental" elements.
Many profitable trades are made moments prior to or shortly after
major economic announcements.
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