Forex Analysis
The object of Forex analysis, is to try and predict which way the market is likely to move. If you get your predictions right, you will make a profit, but if you get them wrong and you will lose your money. There are two types of Forex analysis, Fundamental Analysis and Technical Analysis.
Fundamental analysis involves taking into account the social, economic and political forces that influence the value of a particular country’s currency. If the economy of the country is strong, and the country has a stable government, then the value of that country’s currency can be expected to rise against the currencies of countries with weaker economies.
The most extreme example of a country with a weak (collapsed) economy (at the time of writing - early 2008) is Zimbabwe. The poor state of Zimbabwe’s economy is largely due to horrendous government, with the theft of farm land and plundering of Zimbabwe’s currency reserves by corrupt government officials. The rate of inflation in Zimbabwe is currently over 1,000 percent, so that the currency loses over 90 percent of its value every year. The value of Zimbabwe’s currency is so low, that its value is now literally worth less than the paper it is printed on.
Even in stable healthy economies however, the actions of in particular, reserve banks (e.g. Federal Reserve in the U.S, Bank Of England in the UK etc.) can influence the value of the currency.
Technical analysis involves examining currency prices over a period of time to try and identify trends and patterns. For example, if the value of a particular currency has been steadily increasing over a period of several weeks, then it is likely that the trend will continue in the future, at least in the short term. The trend is the most important aspect of technical analysis. If you can correctly identify a trend, and trade in the same direction you are likely to make profitable trades. Also, the earlier you identify a trend, the more chance you have of making profitable trades.
Ideally, you need to employ both fundamental and technical analysis in your Forex trading.
For example, suppose you were charting the value of the UK pound (GBP) against the U.S. dollar in October - November 2007, using technical analysis only. You would have noticed that for several consecutive days, the GBP was increasing against the USD by around 100 pips every day. So, on November 8, 2007 (the first Thursday in November), you discover the Forex quote: GBP/USD = 2.1104/2.1109. You figure, that by the end of the trading day this should have increased to around: GBP/USD = 2.1204/2.1209. So you buy one standard lot at a rate of 1 GBP = 2.1109 USD, = 47373 GBP. You expect the GBP to rise by 100 pips, so you can sell your 47373 GBP for 2.1204 USD each = $100,450 and earn a nice $450 profit on the day’s trading.
You check the exchange rate a few hours later and you discover that it has moved against you, and the Forex quote: = 2.0906/2.0911. You decide to cut your losses, and sell your 47373 GBP for 2.0906 USD each = $99,294. So instead of making $450 profit, you make a loss of $100,000 - $99,294 = $706. So what happened? The Bank of England sets the UK base interest rate on the first Thursday of every month. On Thursday November 8, 2007, The Bank of England was expected to increase the UK base interest rate, and hence lower the UK inflation rate and increase the value of the GBP. However, the Bank of England unexpectedly left the UK interest rate on hold, which caused the GBP to fall in value instead.
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