A trader trading in the FOREX market relies not just on his intuition and past experience but also more importantly on the data that is at hand. In order to help make informed decisions, there are various analytical tools at hand. Although the movements in the FOREX market fluctuate every now and then, these movements can be more or less predicted.
There are two main methodologies used to analyze the market-
Fundamental Analysis- The main thought behind this idea is that sometimes wrong prices can be quoted for a security. So, eventually profits can be made while trading and at the same time waiting for the market to correct the ‘mistake’. There are two approaches in this analysis. The first is called a ‘Top down Approach’ where an investor looks at factors such as a country’s GDP, trade policies, inflation etc. From such vast data the investor goes on narrowing his search till he has specific data such as the best organizations in an area. In contrast a ‘ Bottom- Up Approach’ refers to beginning with specific businesses in an area irrespective of the region and then working one’s way up the data to arrive at a larger picture.
Technical Analysis- Here, it is believed that ‘trends are your friends’ and so the clue to understanding where the market is headed, is by looking carefully at price trends and investors responses to movements in price. So here, graphs and charts reflecting such trends form the backbone of this theory. However, there are two important theories used which also involve graphs, and help to understand price movements. The first is called the ‘Dow Theory’, which takes a look at stock prices and tries to predict which way they are moving. Although this theory has many takers, it is also thought to be more of a study on trends. The Elliott Wave principle is a tool used more for forecasting trends in the market. According to this theory, movements in the market take place in recognizable patterns.
There are three main kinds of charts,( Line, bar and candlestick) which are used to analyse price trends, price movements and the closing values of the day. Understanding what data these charts reflect and also using them on a daily basis is crucial to a trader. Often, the closing value for a currency on one day is the starting price for the same currency the next day. Furthermore, since the market itself shows so many fluctuations in one day, these charts and graphs are designed to be flexible in nature, allowing multiple changes to be made in one single transacting day. Also, the movements in price shown, are reflective of a worldwide trend or movement, as the FOREX itself is a global market.
Line Chart- Here, two currencies (base and quote) are taken, and the closing value of the price is shown. Here, the graph clearly shows the change in prices over a period of time, enabling traders to understand the ups and downs of the price better. Also, one can compare different currencies better at the same time.
Bar Chart- They are also called as the Open, High, Low, Close charts. Here, just by looking at one bar or segment, a trader can understand the high and low prices, and also the open and close prices for a length of time. This chart gives a better view of the four important parameters that reflect the trading range.
Candlestick Chart- This is the most widely used chart in FOREX first used by the Japanese. It gives the most visible and comprehensive information to a trader. It shows both increase and decrease in prices, how soon the prices changed, and in which direction the price was moving.
In order to know the price of a currency, one has to look at the quotes. A quote is an indicative price which tells a trader what the price of the highest bid and or lowest ask price of a currency is. There are two currencies which are always given in a quote. One is the base currency which is the currency being traded on, and the second is the quote currency which is the currency being traded for. Let us look at an example :
Yen and US dollar quote- JPY/USD 2.5667/ 70
Here the Yen is the base currency and the USD is the quote currency. The symbol used in the FOREX market to signify a yen is JPY and to denote a US dollar is USD. There are two prices, which are shown. The number to the left i.e. 2.5667 signifies the bid price, which is the trader’s selling price. The second number to the right of the slash denotes only the last two digits of a number and shows the asking price or the price at which the currency was bought, which is 2.5670. By looking at such quotes, traders can understand which currencies are available for sale.