Making money trading forex, or in fact any commodity or asset, is all about buying low and selling high. There is an old saying that paraphrases as “you make your money when you buy.” What this means basically is that buying below market value today allows you to build in a greater margin when you sell tomorrow. When dealing with forex trading there are two schools of thought that can be applied to predicting successful price entry and exit points, and these are known as technical analysis and fundamental analysis.
Technical analysis in its purest form revolves around using algorithms to interpret chart movements and predict likely trends. Depending upon the sophistication of the software package, there can be multiple algorithms working at the same time. When these various algorithms begin to coincide, that is when trading signals begin to appear and the more algorithms that converge at the same time the stronger that trading signal becomes. An experienced trader will customize their reaction to these signals based upon their trading policy i.e. high, medium or low risk. The lower the element of risk the stronger the trading signal must be and vice versa.
Fundamental analysis is a much more subjective process that takes into account the wider world at large e.g. economic data, geo-political influences, employment figures, bank rates, trade deficits, government budget deficits etc. This data is collated and used to calculate what is known as the intrinsic value of a particular currency and by extrapolation, the exchange rate with another currency. Once this intrinsic value is calculated, it can then be compared to actual exchange rates in the market place. If sufficient margin exists at that moment in time then a trading opportunity will occur e.g. if a position is overpriced then that will produce a selling signal and vice versa.
As we can see, both schools of thought can be used to predict likely exchange rates. However, they each come at the problem from an entirely different direction. Fundamental analysis for a start is very subjective. How good or bad a set of economic results are is a very grey area and open to interpretation. And if each set of results is open for discussion, then the net result of all the data combined can have a relatively large margin of error. Major trends can be identified but usually only after they occur and by then, the best trade points may already have been missed. Technical analysis doesn’t seek to explain or understand the causes of price fluctuations, only that they happen and what will be the likely effect on the current price of that movement.