This post follows from Forex 101 post that introduces the reader to the basics of forex trading. If you haven’t read the post on forex basics l would encourage you to read it, before tackling the concepts that l will introduce in this post.
Traders often say, “The trend is your friend.” By this traders mean when you trade you have to identify the dominant trend and buy or sell accordingly:
- Buy when the trend is moving up,
- Sell when the trend is moving down
- Do nothing when there is sideways movement.
So this article will discuss some of the methods that are used to identify the trend. The two popular methods used are Technical analysis and Fundamental Analysis.
Technical analysis involves analysing charts and identifying patterns. Most traders use Japanese candlesticks together with technical analysis indicators to do this. The candlesticks look like the image below. Let’s assume we are looking at Candlestick charts on daily exchange rates. The High is the highest exchange rate that was reached during the day, and similarly the Low is the lowest exchange rate reached during the day. The Close is the last exchange rate that was reached at the end of the day and the Open is the exchange rate at the beginning of the day. With currencies some other popular periods – apart from ‘1 Day’- are 1 minute, 5 minute, 15 minute, 1 Hour, 4 Hours, 1 week and 1 month. In order to aid candlesticks, traders also use technical analysis indicators such as the ‘Stochastic Oscillator’ and ‘MACD’ (Moving Average Convergence and Divergence).
Fundamental analysis looks at economic events or indicators that can affect the exchange rate. The major driver of currencies are interest rates. If you expect USA’s interest rate to increase, then you can expect the exchange rate of the US Dollar to the Rand (USDZAR) to rise and vice-versa. Other economic indicators to watch are inflation rates, unemployment rates and GDP (Gross Domestic product).