Forex trading, or trading in the foreign exchange market, involves buying and selling currencies to profit from fluctuations in exchange rates.
As a forex trader, the path to success is paved with informed decisions. A crucial element of this decision-making process lies in the type of analysis you employ.
So the key question often asked by novice traders is: “Which type of analysis is best for forex trading?”
Ahhhh, the million-dollar question…
The answer isn’t straightforward. It depends on your individual trading style, risk tolerance, and time commitment.
There’s no one-size-fits-all answer, as each analysis type offers unique advantages and caters to different trader profiles.
However, understanding the three main types of analysis—technical, fundamental, and sentiment—can help you determine which approach or combination of approaches is best suited to your needs.
Throughout your journey as an aspiring trader, you will find strong advocates for each type of analysis.
Whereas technical analysis (TA) involves poring over charts to identify patterns or trends, fundamental analysis (FA) involves poring over economic data reports and news headlines.
Hardcore traders in the technical analysis camp scream, “Fundamental analysis doesn’t matter! FU to FA! It’s already embedded in the price, which you can see on the charts!”
Hardcore traders in the fundamental analysis camp scream, “Technical analysis is just a bunch of imaginary lines and drawings! Useless fake voodoo magic! TA is BS!”
While folks in the sentiment analysis camp are….observing the two camps fight and monitoring their level of sentiments toward each other! 🤣
Fortunately, the different types of market analysis complement each other.
Even hardcore technical traders may find useful fundamental nuggets that can help with their technical analysis. And vice versa.
In real-world markets, prices are constantly changing, and usually develop trends. Those changes in prices can and do affect fundamentals.
This means that trends in prices affect fundamentals just as fundamentals affect prices.
And as you’ll find out in later lessons, identifying trends is a huge part of technical analysis.
Do not be fooled by these one-sided extremists! One is not better than the other…they are all just different ways to look at the market.At the end of the day, you should trade based on the type of analysis you are most comfortable and profitable with.
Three Types of Analysis
Here’s an overview of each type of analysis:
| Analysis Type | Focus | Time Horizon | Suitable for Traders Who… | Key Tools & Indicators |
|---|---|---|---|---|
| Technical Analysis (TA) | Historical price data, charts, and patterns | Short-term | Prefer quick decisions based on current market conditions, are comfortable with charts and indicators, believe in historical patterns repeating. | Trend lines, moving averages, oscillators, chart patterns. |
| Fundamental Analysis (FA) | Economic, political, and social factors influencing currency values | Long-term | Focus on the bigger economic picture, are comfortable with research and interpreting economic news, want to understand the reasons behind market movements. | Economic indicators (GDP, inflation, employment), central bank policies, geopolitical events. |
| Sentiment Analysis (SA) | Overall market mood and positioning | Short to medium-term | Analyzes market sentiment and trader emotions to gauge market direction. Seek a contrarian edge, want to understand crowd psychology and positioning, look for potential turning points when sentiment is extreme. | Commitment of Traders (COT) report, social media sentiment, options data. |
To recap, technical analysis is the study of currency price movement on the charts while fundamental analysis takes a look at how the country’s economy is doing.
Market sentiment analysis determines whether the market is bullish or bearish on the current or future fundamental outlook.
Fundamental factors shape sentiment, while technical analysis helps us visualize that sentiment and apply a framework to create our trade plans.
Those three work hand-in-hand-in-hand to help you come up with good forex trade ideas.All the historical price action and economic figures are there – all you have to do is put on your thinking cap and put those analytical skills to the test!
Let me pull out that three-legged stool again just to emphasize the importance of all three types of analysis.
Take out one or two legs of the stool and it’s going to be shaky, right?!
In order to become a true forex trader, you will need to know how to effectively use these three types of market analysis.
Don’t believe us?
Let us give you an example of how focusing on only 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 in GBP/USD. I love my charts. Mwah. 😘 Now show me the money!”
- You then proceed to buy GBP/USD with a big fat smile on your face (the kind where all your teeth are showing). 😄
- You take a selfie of this big grin and post it on Instagram. 🤳
- Then you do a happy dance and post that on TikTok. 💃
- But wait! All of a sudden the trade makes a 100 pip move in the OTHER DIRECTION!
- Little did you know, but the UK just gave an FU to the EU.
- Since you just look at charts, you have no clue WTF an EU is. So you Google it.
- You learn that it stands for the European Union, which is an economic and political union involving 28 European countries, that allows free trade, which means goods can move between member countries without any checks or extra charges.
- OMFG! You now just realize that it’s probably serious if the UK wants to do this. Their economy could be devastated. Lots of people might lose their jobs. 🤯
- Suddenly, everyone’s sentiment towards Britain’s market turns sour, and everyone trades in the opposite direction! 😖
- Your big fat smile turns upside down and you start getting angry at your charts. 🤯
- You throw your computer on the ground and begin to pulverize it. (You take a photo of it and tweet it out.)
- You just lost a bunch of money, and now your computer is broken into a billion pieces. (But your tweet now has a million likes.)
- And it’s all because you completely ignored fundamental analysis and sentimental analysis. 💀
(Note: This was not based on a real story. This did not happen to us. We were never this naive. We were always smart forex traders… From the overused sarcasm, we think you get the picture.)
Ok, ok, so the story was a little over-dramatized, but you get the point.
Remember how your mother used to tell you as a kid that too much of anything is never good?Well, you might’ve thought that was just hogwash back then but in forex, the same applies when deciding which type of analysis to use.
Don’t rely on just one.
Instead, you must learn to balance the use of all of them. It is only then that you can really get the most out of your trading.
Where do we go from here?
Now that you’re done with Kindergarten and learned a little bit about each type of analysis, it’s time to delve much deeper!
Here’s what’s in store for the next few years of your life…
We’re kidding, we’re kidding! We’re talking about the next few school years in the School of Pipsology.
Elementary school is the beginner’s guide to technical analysis.
You’ll learn all about the dynamics behind price action, such as support and resistance levels, Japanese candlesticks, and technical indicators like moving averages and MACD.
You’ll experiment with leading and lagging indicators and discover how to use them in coming up with trade ideas.
Sounds pretty exciting, doesn’t it?
The remaining years of Middle School and High School are devoted to studying more technical analysis tools.
We’ll take a look at the more advanced forex tools also such as pivot points, divergences, Heikin Ashi, Elliott Wave Theory, and harmonic price patterns.Sounds fancy? It’s because they are! Bet you can’t wait to get started on those!
College will be a bit more complicated since you’ll be tackling both fundamental AND sentiment analysis at the same time.
Talk about hitting two birds with one stone!
You’re the stone and the birds are… well, you get the point.
A couple of reasons why we’re putting fundamental and market sentiment analysis together:
- By the time you reach college, you’ll be so hooked on learning more about forex that one lesson simply won’t be enough.
- It is hard to draw the line between fundamental analysis and market sentiment analysis, but you’ll get there with deliberate practice.
As we mentioned earlier, fundamental factors are mostly responsible for shaping market sentiment.
Those two types of analysis would take up both freshman and sophomore years of college.
