Making predictions regarding forex market movements may be a difficult task. However, modern traders have access to more resources and tools than ever before. Forex (short for “foreign exchange”) is one of the most popular and busy markets in the world. In terms of it, more than $5 trillion a day is traded, making billions with which stock markets operate look insignificant. This article will focus on different tools and approaches.
The Approaches to Predicting Forex Movements
Before you select an approach to forex trading, you need to craft a basic strategy. Among other things, it should include the currency pairs you want to trade. Some traders focus on major pairs, such as GBP/USD, EUR/USD, or USD/JPY. Meanwhile, other investors operate less popular pairs with equal efficiency.
Another thing you need to consider is the timeframe within which you want to trade. You can start afresh every single day, focus on more extended periods between 2 and 14 days, or even hold positions for months. Everything depends on your strategy and willingness to take risks.
Besides, you need to think about whether you want to deal with proactive forex trading or alternative models. These include momentum trading that relies on rapid price movements at the beginning of long-term trends and range trading based on spotting the points in which resistance or support occurred in the past and expecting for these patterns to repeat in the future.
Fundamental and Technical Analysis in Forex Predictions
Forex trading relies on insights to a significant extent. In turn, they may be obtained through fundamental or technical analysis. In this context, fundamental analysis means the process of analyzing the external events and evaluating their impact on the currencies’ value. Meanwhile, technical analysis attempts to predict future currency price fluctuations based on statistics, historical price charts, and specific trading indicators.
In forex trading, fundamental analysis can be helpful in the identification of a currency that is currently mispriced and tending to change in value soon. It can be useful for making predictions regarding long-term price movements. There are several factors to be considered in the first place when conducting a fundamental analysis:
- economic growth
- interest rates
- trade and capital balances
- employment and wages
Predicting Forex Movements With the Help of Economic Calendar
To conduct functional analysis, you do not always have to go through a variety of news platforms and analyze all the information they provide. You can use an economic calendar, which is an easy and convenient tool to aggregate all data you need in this regard. This instrument includes information on all major events with the capability of influencing forex trading that will take place in the future, such as political meetings, speeches of world leaders and central banks’ heads, and other events of a similar scale. However, when relying on an economic calendar, one has to remember that different economies have different events as primary driving factors, which is necessary to consider when setting this instrument up.
Unlike its fundamental counterpart, technical analysis does not attempt to determine the reasons behind the price movement. Instead, it looks for patterns and regularities in the historical performance, using them as guidelines for predicting future short-term fluctuations. Technical analysis relies on determining four major data points occurring repetitively: the opening, highest, lowest, and closing price. These aspects can be viewed as common parameters used for technical analysis.
While utilizing the concepts of patterns and signals, technical analysis mostly focuses on the phenomenon of trends. A trend develops when a series of patterns evolves. It always belongs to one of the three major forms: uptrends, sideway trends, and downtrends, the essence of which can be easily understood based on their names.
To identify trends, a trader can use a wide variety of tools. However, the one that is most frequently applied for reaching this objective is moving averages. It is a tool utilized to identify forex trends by determining the average exchange rate existing in a particular period of time. Besides, it is a basis for MACD (moving average convergence divergence), an instrument that identifies when short-term and long-term moving averages cross and, thus, allows a trader to realize when the exchange rates are most likely to head higher.
Another technical aspect that is frequently used for the identification of forex fluctuations is the trends’ strength. To determine this indicator, one may apply various instruments, the list of which includes (but is not limited to):
- The Ichimoku Cloud
- Relative strength index
- Standard deviation
- Bollinger bands
Besides, there are several specific technical instruments that should be discussed separately from the others.
The Econometric Approach
Basically, this approach to the identification of future forex fluctuation relies on the combination of various technical indicators. The trader should determine which particular indicators to consider on his or her own, so that the data obtained is the most suitable to his or her strategy.
The Relative Economic Strength Approach
This model lies on the verge of technical and fundamental analysis. It considers the influence of outside factors that have something to do with state and world economies’ fluctuations on the shifts and changes in the forex market. Traders resorting to this approach use these pieces of data to determine whether the particular economy is strong or weak and, consequently, whether this country’s currency will gain or lose in value.
The Purchase Power Parity Approach
This framework aims to predict the size of the actual exchange rate based on citizens’ purchasing power. It relies on the theory assuming that the goods’ and services’ prices in different countries should be equalized. Consequently, if the citizens’ purchasing power is higher or lower than it should theoretically be, the equalizing fluctuations may soon start occurring with the country’s currency.
The Real Interest Rate Approach
According to this approach’s central provision, the currency of a country where higher interest rates exist has more chances to increase in value than that of a country with lower interest rates. This idea is based on the assumption that higher interest rates will attract more foreign investment and, thus, increase the demand for the state’s currency.
The Balance Payment and Asset Market Approaches
The first of these theories assumes that a country with imports exceeding exports will face currency depreciation and vice versa. The second approach is similar; however, it directly focuses on the inflow and outflow of foreign investment in the country as the factors causing an increase and decrease in the local currency’s value, respectively.
Predicting Forex Fluctuations Using Sentiments
This last approach attempts to determine forex movements based on market sentiments. It is efficient when applied to stocks, leading to a straightforward pattern: lower volumes of trading indicate the souring market mood while increasing volumes suggest that activity and interest levels are higher. However, it is problematic to use it concerning forex since it is challenging to track the trading volumes in this niche due to the commodities being traded over-the-counter. In this regard, it can be relatively effective only when applied to forex futures. If their prices are significantly different from the spot prices, the market can be identified as either bearish or bullish. However, considering that, in forex trading, the spot market is significantly larger than that of the futures, the sentiment approach still cannot be defined as explicitly useful.