Three types of market analysis

There are three main types of analysis traders use to analyse price action in the financial markets. These are: Fundamental, Technical and Sentiment. Traders often find that their trading style determines which kind of analysis they will find most beneficial. It is often the case that a trader will incorporate more than one of these methods into their trading strategy.

Fundamental analysis

Fundamental analysis focuses on economic, social and political factors that have the tendency to affect the supply and demand of an asset. It looks at the potential moves of a country’s currency through the strength or weakness of that particular country’s economic outlook.

Fundamental traders study macroeconomic indicators, data which is published regularly, at a particular time, by governmental agencies and the private sector. There are a number of key indicators fundamental traders analyse:

• Central bank interest rate decisions
• Labour market (employment figures)
• Economic growth (GDP growth)
• Inflation (CPI)
• Production and trade data
• Housing data
• Retail sales

In forex, a fundamental trader will analyse a country’s macroeconomic data, alongside the country’s central bank policy to get a better understanding as to the state and health of the country’s economy, and whether to trade the future price movements of their currency. Generally speaking, positive data releases are bullish for a country’s currency, while disappointing reads are bearish for a currency. However, price movement in currency pairs also depends on market sentiment and expectations for the data. All in all, these data releases and major events can often represent good trading opportunities.

Central banks are known for being the great movers of markets, especially those of major currencies, first and foremost the US Federal Reserve. Naturally, data out of the U.S tends to have the biggest impact on the financial markets, simply because the U.S is the world’s biggest economy. For example, the US jobs report known as US non-farm payrolls, is a key data release for USD traders. A high reading is generally regarded as positive (bullish) for the USD, while a low reading is seen as negative (bearish) for the currency. However, market reaction depends heavily on the previous month’s review, market consensus and accompanying data (e.g. the US unemployment rate and wage growth). An oil trader would focus on the weekly US oil inventories report as it tends to generate large price volatility in WTI and Brent.

Geopolitical events also play an important role in the movement of prices - major elections, political unrest, global instability, countries in crisis - can cause widespread instability in the financial markets.

Technical analysis

Technical traders study past price movements on charts of their chosen trading instrument, to determine current trading conditions and potential future price movement. Using the charts they try to analyse and evaluate price trends and patterns, looking for signals to help establish profit opportunities in the future. To do this they use technical charting tools such as indicators and oscillators. There are many tools technical traders use to analyse the markets, however below are some of the commonly used indicators:

• Moving averages (Simple Moving Average, Moving Average Convergence Divergence, etc.)
• Bollinger bands
• Relative Strength Index (RSI)

Using technical indicators and drawing tools like above, technical traders will look for price patterns on the chart, such as “triangles”, “flags” and “double bottoms”. Based on the pattern, they will determine their entry and exit points.

Sentiment analysis

Using sentiment analysis, you can gauge whether the market is currently bullish or bearish. The first step in sentiment analysis is determining the current “mood of the market”, as the price movement on an instrument has a strong correlation with market sentiment.

Fundamental factors primarily shape sentiment in the forex market, including interest rates, employment, economic growth and trade, as well as geopolitical events. Commodity prices also affect currencies, especially of commodity-export dependent countries, such as Canada and Australia.

How does the market react to different news announcements?

In general, forex traders tend to be long or ‘bullish’ when economic news emerging out of a country is positive or strong, and short or ‘bearish’ when economic news emerging is negative or weak.

However, price movement on a currency will also depend on whether the data released misses or exceeds analyst estimates, and therefore market expectations. Depending on how the market reacts to such news over a period of time, will help tell a trader the overall market sentiment of a currency. To some extent, every trader will incorporate their own perception of market sentiment into their trading strategy.

Take a look at the rest of our trading guides on trading forex and CFDs to learn about trading strategies, what affects the markets and how to build a trading plan. View other trading guides →