There are two basic approaches to analyzing the currency market, fundamental analysis and technical analysis. The fundamental analyst concentrates on the underlying causes of price movements, while the technical analyst studies the price movements themselves.
A Technical Analysis is what one uses to attempt to predict future price movements, based on past time framed analysis and the reading / understanding of graphics. Although within a Technical Analysis various thought patterns exist, generally all are based on historical graphics of a currency. As long as one realizes the various differences of Fundamental and Technical Analysis, both can be used to parallel one another, even though both may present different conclusions.
The study of specific factors, such as wars, discoveries, and changes in Government policies, which influence supply and demand, and consequently prices in the market place.
Fundamental analysis comprises the examination of macroeconomic indicators, asset markets and political considerations when evaluating a nation´s currency in terms of another. Macroeconomic indicators include figures such as growth rates; as measured by Gross Domestic Product, interest rates, inflation, unemployment, money supply, foreign exchange reserves and productivity. Asset markets comprise stocks, bonds and real estate. Political considerations impact the level of confidence in a nation´s government, the climate of stability and level of certainty.
Sometimes governments stand in the way of market forces impacting their currencies, and hence, intervene to keep currencies from deviating markedly from undesired levels. Currency interventions are conducted by central banks and usually have a notable, albeit a temporary impact on FX markets. A central bank could undertake unilateral purchases/sales of its currency against another currency; or engage in concerted intervention in which it collaborates with other central banks for a much more pronounced effect. Alternatively, some countries can manage to move their currencies, merely by hinting, or threatening to intervene.
Technical Analysis or Fundamental Analysis ?
One of the dominant debates in financial market analysis is the relative validity of the two major tiers of analysis: Fundamental and technical. In Forex, several studies concluded that fundamental analysis was more effective in predicting trends for the long-term (longer than one year), while technical analysis was more appropriate for shorter time horizons (0-90 days). Combining both approaches was suggested to be best suited for periods between 3 months and one year. Nonetheless, further empirical evidence reveals that technical analysis of long-term trends helps identify longer-term technical "waves", and that fundamental factors do trigger short-term developments.
But most traders abide by technical analysis because it does not require hours of study. Technical analysts can follow many currencies at one time. Fundamental analysts, however, tend to specialize due to the overwhelming amount of data in the market. Technical analysis works well because the currency market tends to develop strong trends. Once technical analysis is mastered, it can be applied with equal ease to any time frame or currency traded.