Every trader wants to be profitable. After opening an account with a cheap and reliable broker, it is time to learn the 2 main ways currency traders make money – fundamental analysis (FA) and technical analysis (TA).
#1 Fundamental Analysis (FA)
FA looks at the factors which affect the economy. Such factors include interest rates, unemployment rate, policies and more. At the very essence of FA is the demand and supply of the country’s currency. Let’s explore further.
Strength Of Economy
Do you remember that currencies are traded based on the difference in strength of 2 economies? If you believe that Europe’s economy is faring better than USA’s, you would go long on EUR/USD.
Interest Rate & Currency Value
Interest rate is used as a tool to cool or stimulate the economy.
In a booming economy, the central bank will likely raise interest rates to prevent the economy from overheating. With a higher interest rate (also known as the cost of borrowing), debtors will want to repay their loans as soon as they can to avoid paying more in the form of interest.
On the other hand, when the economy is sluggish, central banks will likely lower interest rates to encourage more loans for the expansion of business activities. This is due to the fact that the cost of borrowing has decreased.
As a trader, what does this mean to you?
The currency of the country with a higher interest rate is more attractive. Imagine you are living in a developed country with high interest rates. Would you be more enticed to save your money in a local bank as compared to saving your money in another country with lower interest rates?
A higher interest rate will attract more inflow of funds and thus indirectly increase the demand for that currency. A higher demand for a currency will lead to the increase in value of the same currency.
Please note that I am referring to the countries of major currencies.
With this said, the long-term direction of the value of a currency hinges heavily on the interest rate policy direction undertaken by the central bank.
You can get the data to monitor on the health of the economy at Forex Factory. Forex Factory also indicates the level of impact the data has on the country’s currency, which is highly beneficial.
For a more in-depth understanding of the many economic indicators, I highly recommend this book by The Economist.
#2 Technical Analysis (TA)
TA is the study of price movement. Technicians (practitioners of TA) believe that news, events, and the outlook of the economy have been priced in.
The actions of market participants leave behind a footprint on charts and TA will help you to uncover their footprints.
Past Prices Are Significant
This is a core belief in TA. Historical prices can determine current and potential price movements due to human psychology and behavior.
As the saying goes, history tends to repeat itself. Through the study of the technical charts, you can identify potential zones for trend continuation or change.
Technicians look for similar patterns that have been formed in the past, studying the likelihood of a similar movement in the near future.
Technicians use a whole host of tools to help them plan their trade. Some of the common tools include support and resistance, trendlines, channels, Fibonacci calculations, and moving averages. Combine this with their knowledge of price action, technicians sieve for the most promising currencies to trade.
Both methods of analysis can be profitable. You may even want to incorporate elements of both methods!
Before you move on to the next article, I encourage you to digest the Foundation Stock Course (from Lesson 4).
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