There are many reasons why the forex market can be profitable. Examples include the high amount of liquidity in the market, great leverage potential, and even how volatile the foreign exchange rates are in the market.
However, volatility also happens to be the biggest limitation of the forex market. In other words, while fluctuating foreign exchange rates offer great opportunities for profit, they can also lead to massive losses.
The trick to succeed in the forex market is to simply have all your bases covered through extensive analysis of trends and patterns. There are primarily three ways through which you can analyse the forex market. Consider the following.
The forex market is a free market, if you use economy terms. Economists, in fact, believe that this is the only market that is free of all artificial controls in the world. This means that the market reacts to natural market forces.
In other words, causality is a big factor when it comes to analysing the market i.e. the relationship between cause and effects. When an event occurs in the world that can have an impact on the market, then it can be analysed by traders to determine which way the foreign exchange rates will move in the market.
These causes or factors are known as fundamentals. Typically, fundamental analysis involves the study of various relevant forex news items that can affect the market. Conversely, any movement in the market can be explained on the basis of forex news events.
Technical analysis is a process which is based on the simple fact that if a trend has occurred in the market before, then it will occur in the same way again provided the conditions are the same.
This is the basis of technical analysis, which, in practical terms, boils down to analysing charts and statistics pertaining to the current state of the market and using precedence to project foreign exchange rate movements. Needless to say, this is the more popular method of analysing the market today because it makes short term projections possible.
Sentimentality of the Market
Sentimentality of the market can be described as the overbearing environment in which traders function. Owing to various influencing factors and the state of the market, the majority of traders form an opinion of how foreign exchange rates are going to behave.
This communal opinion often ends up having more of an influence on the market than real world factors. Assessing the prevailing beliefs in the market, however, is extremely difficult and requires traders to have a lot of experience.
How to Analyse the Market
Most traders feel trapped between these three modes of analysing foreign exchange rates because each of them has its own strengths and weaknesses. Therefore, it can be said that the best way to judge which direction the foreign exchange rates will take is to combine all these analytical processes into one coherent strategy wherein fundamentals give the overall picture, technicals give specific leads, and sentimentality takes into account the psychology of the market.