Fundamental and technical analysis
Without the toolbox that makes it possible to understand the currency market, every deal is pure gambling. There are two basic methods of analysis that can be used independently of each other to create a winning trading strategy.
Fundamental analysis applies macroeconomic theories to markets to predict future moves. And what fundamental forces are driving the foreign exchange market?
Trade Balance: This is the difference between the value of a country’s exports and imports – that is, this is a description of incoming and outgoing foreign currency flows. The balance is positive if the export exceeds the import, and if the import exceeds the export, there is a deficit in the trade balance. When a country has a deficit in its trade balance, it is looking for a foreign currency and is forced to sell significant amounts of its own currency in order to be able to pay for imports of goods and services. Consequently, a balance of payments deficit usually leads to a devaluation of the local currency against the prices of other currencies. Currencies associated with long-term surpluses will be stronger than those associated with persistent deficits. Trends are also important. An improved trade balance makes one local currency more expensive than another, which is linked to a trade balance that is deteriorating or stable.
Relative inflation rates: If country A has a higher inflation rate than country B, then A’s currency should be less than that of B – for purchasing power parity to apply.
Interest rates: International capital flows are routed to a return on lower inflation, which creates additional demand for currencies with higher real interest rates, which in turn increases their exchange rate.
Expectations and speculation: Markets are moving ahead of expectations. Market enthusiasts’ attitudes about the future value of inflation, the pace of economic growth, and changes in employment and unemployment are sufficient to influence the exchange rate long before this trend becomes apparent.
It is important to know that these economic powers act in concert. However, it is very difficult to determine where the interacting economic forces will take the market. The decision, according to some, is in the technical analysis.
Technical Analysis (TA) is a theoretical concept that examines the dynamics, speed and amplitude of a change in the cost of a financial asset, based on a graphical representation of the price movement. Unlike the predictive methods of analysis, TA has the sole purpose of generating specific trading ideas with clearly defined price levels for opening, managing, and finalizing a trade deal.
Below are a brief overview of the technical analysis tool used to define the current market trend, which in turn is a prerequisite for a successful business transaction.
Linear: Graphic representation of the price dynamics of a financial instrument over a given period. The line is compiled by linking the closing prices for a specific time interval.
Bar chart: An image of the price movement represented by vertical strips at set intervals – for example, every 30 minutes. Each bar has four “hooks” symbolizing opening, closing, highest, and lowest (OHLC) prices within this selected time interval.
Kendall Graphics (Japanese Candles): A variation of the bar graph, with the difference that depicts OHLC as “candles” with a wick at each end. When the opening price is higher than the closing price, the candle is a “sword”. When the closing price is higher than the opening price, the candle is “whip”.
A pronounced trend in the price of a financial asset moving in a certain direction within a specific time period. This market phase is characterized by an imbalance between supply and demand, with the predominance of buyers being the reason for the upward trend, but the predominance of sellers for a downward trend. Trend-phase dynamics imply a large price amplitude for a short period of time.
Price fluctuations, which fail to register higher than the preceding, maximum or lower minimum, respectively, form a range of ranges. The supply and demand forces are balanced within the framework of price consolidation, which in a graphical representation shows a small price amplitude for a prolonged period of time. The rang phase follows the trendline, thus completing the full market cycle.
Levels of support and resistance: Extremisms in which price movements change their direction, define market levels of resistance and support. In the trending phase, the bottoms of the ascendant and the top are significant in the downward trend, marking the predominance of the moving sentiment, and in the rang phase these are the limits of the consolidation. The important price levels that are above the current market price are called resistances, and those underneath it – supported.
Support: Price zones where the interest in buying dominates over sales leads to levels of support. The highest degree of importance is the static support zones whose value does not change over time – for example, the bottoms of the ascending trend and the lower boundary of the rang phase. A line built at the bottom of an upward trend defines dynamic support whose value is steadily increasing with the trend.
Resistance: Resistance levels show reluctance for the majority of market participants to buy above a certain price. Static market resistance is present at each extreme preceding downward movement, with the highest levels of significance being peaks within the downward trend and the upper limit during consolidation. The line connecting the vertices to a downward trend is a dynamic resistance whose value gradually decreases as the trend develops.
Creeping Average: Their goal is to smooth out the peaks and falls in the currency’s price cycle for the projected period and also to show a trend in price.
There are two main types of creeping mean:
Simple (SMA): When past and current data is assumed to be equally significant and weighted identically.
Weighted (WMA): Current data is considered to be more important than past data and has a higher weight. The weighing factor is in the form of a “smoothing constant,” which increases exponentially over time.
If the price is in two or more moving averages, this is considered a bearish signal – and vice versa.
Stochastic oscillators: Stochastic oscillators are momentary indicators to indicate when to buy or sell. They have two components:
Line “% K” measures the difference between the most recent closing price and the lowest bottom as the percentage of the difference between the highest peak and the lowest bottom, measured over a period of time (eg 14 days).
Line “% D” tracks three periods (e.g., days) of creeping mean of “% K”.
A rise in% K vs. ‘% D’ counts as a buy signal – and vice versa.
One currency is considered overpriced when the oscillator reaches 80. It is assumed that an oscillator below 20 indicates that the currency is oversold.