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Wednesday, September 10, 2008

Types of Trading

There are 2 types of analysis you can take when approaching the forex:

Fundamental analysis and Technical analysis.
There has always been a constant debate as to which analysis is better, but to tell you the truth, you need to know a little bit of both. So let’s break each one down and then come back and put them together.

Fundamental Analysis
Fundamental analysis is a way of looking at the market through economic, social and political forces that affect supply and demand. (Yada yada yada.) In other words, you look at whose economy is doing well, and whose economy sucks. The idea behind this type of analysis is that whoever’s economy is doing well; their currency will also be doing well. This is because the better a country’s economy is, the more trust other countries have in that currency.

For example, the U.S. dollar has been gaining strength because the U.S. economy is gaining strength. As the U.S. interest rates keep increasing, the value of the dollar continues to increase. And that is what we call fundamental analysis.

Technical Analysis
Technical analysis is the study of price movement. In one word, technical analysis=charts. The idea is that a person can look at historical price movements, and based on the price action, can determine on some level where the price will go. By looking at charts, you can identify trends and patterns which can help you find good trading opportunities.

The most IMPORTANT thing you will ever learn in technical analysis is the trend! Many people have a saying that goes, “The trend is your friend”. The reason is that you are much more likely to make money when you can find a trend and trade in the same direction. Technical analysis can help you identify these trends in its earliest stages and therefore (did I just say therefore?) provide you with very profitable trading opportunities.

So which type of analysis is better?
The answer is neither. You need both types of analysis to become a successful trader. Here’s an example of how focusing only on one type of analysis can turn into a disaster.

Let’s say that you’re looking at your charts and you find a good trading opportunity. You get all excited thinking about the money that’s going to be raining down from the sky. You say to yourself, “Man, I’ve never seen a more perfect trading opportunity. I love my charts.” You then proceed to enter your trade with a big fat smile on your face (the kind where all your teeth are showing). But wait! All of a sudden the trade makes a 30 pip move in the OTHER DIRECTION.

Little did you know that there was an interest rate decrease for your currency and now everyone is trading in the opposite direction? Your big fat smile turns into mush and you start getting angry at your charts. You throw your computer on the ground and begin to pulverize it. You just lost a bunch of money, and now your computer is broken. And it’s all because you completely ignored fundamental analysis. Ok ok, so the story was a little over dramatic, but you get the point. Just remember to incorporate both types of analysis before you trade

There are 2 types of analysis: Fundamental and Technical

  • Fundamental analysis is the analysis of a market through the strength of its economy. (i.e. the dollar gets stronger because the US economy is getting stronger)
  • Technical analysis is the analysis of price movements. Technical analysis = charts.
  • Technical analysis also helps us identify trends which can help us find profitable trading
  • To become a successful trader, you must always incorporate both types of analysis.

Source quoted from LLC

1 comment:

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