Analyze this: 5 tips for good market analysis

Education

How to evaluate the market

Trading is a
process that can be broken in 2 stages: market analysis and the trade itself.
To the latter we attribute things like opening an order, choosing position size
and making sure that your actions conform to the rules of risk management.

This part of the
process is very important. However, you shouldn’t underestimate the relevance
of market analysis as well. In this article, we have gathered recommendations
regarding the fundamental and technical analysis of the currency market.

Tip 1. Analysis first, trading second 

It often happens
that those who only start their trading career form some random trade ideas in
their minds and then start looking for the arguments that would justify their
thoughts. This is a very wrong approach.

It’s the market
analysis that should provide you with trade ideas and not the other way round.
When you reverse this order, you lose the ability to think objectively. You
will interpret everything you see on the charts as confirmations of your
initial idea. There’s no point in such analysis because it doesn’t really prove
that this idea was good.

Make sure that
when you approach the market you have as clear and free mind as possible. This
will allow you to grasp the real profit opportunities.

Tip 2. Confirmations

Once you have the
idea, make sure that it’s valid. Of course, there’s no way to be 100% sure that
a trade will bring profit. Yet, it’s possible to increase the probability of
success. Most trading systems are based on the simple principle: there’s a
certain sufficient amount of clues you need to gather in order to adopt a trade
idea.

Each trader has
his/her own view on what “sufficient” is. In our opinion, at least 3 clues are
necessary and these clues have to be of different nature, for example, a clue
from price action, a clue from a technical indicator and a clue from
fundamentals.

Tip 3. Fundamental or technical approach?

There are still a
lot of people who like debating which type of analysis is better. At the same
time, ask yourself a question: should we really set limitations here? After
all, these types of analysis are very different.

The fundamental
analysis represents the study of the forces that are driving the market. These
drivers become very important when you trade trends. On the other hand,
fundamental analysis won’t allow you to make precise market entry, while often
enough every pip counts. That’s where the technical analysis chimes in.

It also offers
visual insights in the psychology of market players. For example, a “Head and
Shoulders” pattern clearly shows that bulls lose their ability to push the
price higher. Many traders recognize this distinctive shape of the price action
and act accordingly thus making the pattern a self-fulfilling prophecy.

So, seeing merits
in both fundamental and technical analysis, we propose an evident solution:
combine the two! You may say that that’s too general a recommendation and you
will be right.

How about the
following scheme: for short-term trades, make your decision based on technical
analysis but consult fundamentals in the economic calendar as they can make a
big impact on your trade; for longer-term trades, use fundamental analysis to
identify a trend to follow and then apply technical analysis to find good entry
and exit levels.

Tip 4. Multiple timeframes save the day

Some traders go as
far as to perceive timeframes as different trading instruments. Don’t make this
mistake! Timeframes represent merely a set of lens for different perspectives
and allow a trader to get a better look at the market.

Alexander Elder
has established a classic approach by introducing a triple screen system that
uses 3 timeframes. A trader should start with a bigger timeframe (locate the
overall trend), then switch to a smaller one (find the point where a
counter-trend move ends) and finally open the smallest timeframe (make a
precise entry).

In any case, going
from a larger timeframe to a smaller one is the correct approach because
otherwise you will risk falling victim of the situation we described in tip #1.
So, no matter whether you are a scalper or a position trader, make sure you
reap the benefits of analyzing several timeframes.

Tip 5. Remember about correlations     

Forex market
doesn’t exist in the void. Remember that currencies represent just one of the
ways for investors to store their funds, for speculators to get profit and for
hedgers to protect themselves from big changes in the exchange rates.

As a result,
currencies compete with other assets, such as stocks and commodities for public
attention. The prices of other instruments are denominated in currencies and
this forms yet another tie (that’s why gold/oil are so sensitive to the
dynamics of the USD).

Finally,
currencies are naturally connected to the performance of respective economies.
The latter interact as well, so no wonder that problems in China will pressure
the AUD: China is Australia’s key trading partner. 

As a result, it’s
necessary to have a broad view of the market, follow the general newsflow
related to currencies and global economy and be aware of especially strong
direct and inverse correlations. Examples of direct correlation: AUD/USD and
NZD/USD, XAU/USD and XAG/USD. Example of inverse correlations: EUR/USD and
USD/CHF.       

All in all, market analysis should be an area of
constant improvement for a trader. It’s a key skill both to make your own
trades or to evaluate the ideas of others. Check
Forex news and market commentary at FBS website: we surf
through tons of info to serve you the brief and sharp summary of the most
important things. Good luck in your market analysis and trading!

This article was submitted by FBS.

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