Exchange Rate Analysis centres on 3 things;

  1. Fundamentals
  2. Techinical analysis
  3. Sentiment

 

Fundamentals

Forex fundamental centers mostly around the currency’s interest rate. Other fundamental factors are included such as Gross Domestic Product, inflation, manufacturing, economic growth activity.

When investors are in a risk seeking mode, money follows yield and higher rates could mean more investment. When investors are in a risk adverse mentality, then money leaves yield for safe haven currencies.

A fundamental forex trader will analyze the country’s;

  • Inflation

If inflation in the UK is less than elsewhere in the world, this means goods are cheaper for A. foreign buyers and B. domestic buyers. Because that country would be more competitive, foreign buyers will buy more UK goods and there will be an increase in demand for the Pound sterling which will cause the currency to appreciate in value. The appreciation will also come from a decline in domestic buyers importing goods and instead buying goods in their own country in their own currency. Countries with lower inflation rates tend to see an appreciation in the value of their currency.

  • Central bank interest rate and economic measures

High interest rates are good because it attracts foreign investors who desire to invest in that country and the returns on its currency through depositing money within its banks. Demand for sterling will therefore rise and so the currency will appreciate.

Demand for a currency can rise (raising its price) if;

  1. it is projected that there will be an interest rate hike
  2. Good growth data comes out in terms of gross domestic product/ growth in jobs that is e.g. better than expected

Demand for a currency can drop (lowering its price) if the country is in recession or has a trade deficit ie. on the current account the value of imports (of goods and services) is greater than the value of exports (negative position). If this is financed by a surplus on the financial / capital account then this is OK, but if country is struggling to attract enough capital inflows i.e. borrow to finance a current account deficit, demand for the currency will drop and you will see a depreciation in the currency.

  • Government debt

Under some circumstances, the value of government debt can influence the exchange rate. If markets fear a government may default on its debt, then investors will sell their bonds causing a fall in the value of the exchange rate

 

Technical

For equity traders, they will analyze the price and volume of the shares traded on the exchange. If prices are moving higher on increasing volume, traders will see the demand for shares of that company’s stock and buy. The same applies for currency.

Moving averages, Bollinger Bands, MACD, Relative Strength Index (RSI), and stochastic trends tend to be some of the more common tools in a technical traders tool box.

 

Sentiment

Since people vote with their trades, we can assess through FXCM’s Speculative Sentiment Index (SSI).

If we sense e.g. EUR/USD sentiment and it shows a majority of traders are buyers in the currency pair. Since we know there is a large pool of traders who have already BOUGHT, then these buyers become a future supply of sellers. We know that because eventually, they are going to want to close out the trade. That makes the EUR to USD vulnerable to a sharp pull back if these buyers turn around and sell to close out there trades.

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Candlestick Charts

The “body” of each candlestick represents the opening and closing prices while the candle “wicks” display the high and low prices for each period. Every candle that is blue means the price closed higher than where it opened (often called a bullish candle), and every candle that is red means the price closed lower than where it opened (often called a bearish candle).

Bar Charts

The vertical line is created by the high and low price for the bar. The dash to the left of the bar was the opening price and the dash to the right was the closing price.

Line Charts

This chart type usually only displays closing prices

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