Forex forecasting

Basic Forex forecast methods: Technical analysis and fundamental analysis

This article provides insight into the two major methods of analysis used to forecast the behavior of the Forex market. Technical analysis and fundamental analysis differ greatly, but both can be useful forecast tools for the Forex trader. They have the same goal - to predict a price or movement. The technician studies the effect while the fundamentalist studies the cause of market movement. Many successful traders combine a mixture of both approaches for superior results.


Technical analysis
Technical analysis is a method of predicting price movements and future market trends by studying charts of past market action. Technical analysis is concerned with what has actually happened in the market, rather than what should happen and takes into account the price of instruments and the volume of trading, and creates charts from that data to use as the primary tool. One major advantage of technical analysis is that experienced analysts can follow many markets and market instruments simultaneously.
Technical analysis is built on three essential principles:
1. Market action discounts everything! This means that the actual price is a reflection of everything that is known to the market that could affect it, for example, supply and demand, political factors and market sentiment. However, the pure technical analyst is only concerned with price movements, not with the reasons for any changes.
2. Prices move in trends Technical analysis is used to identify patterns of market behavior that have long been recognized as significant. For many given patterns there is a high probability that they will produce the expected results. Also, there are recognized patterns that repeat themselves on a consistent basis.
3. History repeats itself Forex chart patterns have been recognized and categorized for over 100 years and the manner in which many patterns are repeated leads to the conclusion that human psychology changes little over time.
Forex charts are based on market action involving price. There are five categories in Forex technical analysis theory:
Indicators (oscillators, e.g.: Relative Strength Index (RSI)
Number theory (Fibonacci numbers, Gann numbers)
Waves (Elliott wave theory)
Gaps (high-low, open-closing)
Trends (following moving average).
Some major technical analysis tools are described below:Relative Strength Index (RSI):
The RSI measures the ratio of up-moves to down-moves and normalizes the calculation so that the index is expressed in a range of 0-100. If the RSI is 70 or greater, then the instrument is assumed to be overbought (a situation in which prices have risen more than market expectations). An RSI of 30 or less is taken as a signal that the instrument may be oversold (a situation in which prices have fallen more than the market expectations).Stochastic oscillator:
This is used to indicate overbought/oversold conditions on a scale of 0-100%. The indicator is based on the observation that in a strong up trend, period closing prices tend to concentrate in the higher part of the period's range. Conversely, as prices fall in a strong down trend, closing prices tend to be near to the extreme low of the period range. Stochastic calculations produce two lines, %K and %D that are used to indicate overbought/oversold areas of a chart. Divergence between the stochastic lines and the price action of the underlying instrument gives a powerful trading signal.Moving Average Convergence Divergence (MACD):
This indicator involves plotting two momentum lines. The MACD line is the difference between two exponential moving averages and the signal or trigger line, which is an exponential moving average of the difference. If the MACD and trigger lines cross, then this is taken as a signal that a change in the trend is likely.Number theory:
Fibonacci numbers: The Fibonacci number sequence (1,1,2,3,5,8,13,21,34...) is constructed by adding the first two numbers to arrive at the third. The ratio of any number to the next larger number is 62%, which is a popular Fibonacci retracement number. The inverse of 62%, which is 38%, is also used as a Fibonacci retracement number.Gann numbers:
W.D. Gann was a stock and a commodity trader working in the '50s who reputedly made over $50 million in the markets. He made his fortune using methods that he developed for trading instruments based on relationships between price movement and time, known as time/price equivalents. There is no easy explanation for Gann's methods, but in essence he used angles in charts to determine support and resistance areas and predict the times of future trend changes. He also used lines in charts to predict support and resistance areas.Waves
Elliott wave theory: The Elliott wave theory is an approach to market analysis that is based on repetitive wave patterns and the Fibonacci number sequence. An ideal Elliott wave patterns shows a five-wave advance followed by a three-wave decline.Gaps
Gaps are spaces left on the bar chart where no trading has taken place. An up gap is formed when the lowest price on a trading day is higher than the highest high of the previous day. A down gap is formed when the highest price of the day is lower than the lowest price of the prior day. An up gap is usually a sign of market strength, while a down gap is a sign of market weakness. A breakaway gap is a price gap that forms on the completion of an important price pattern. It usually signals the beginning of an important price move. A runaway gap is a price gap that usually occurs around the mid-point of an important market trend. For that reason, it is also called a measuring gap. An exhaustion gap is a price gap that occurs at the end of an important trend and signals that the trend is ending.Trends
A trend refers to the direction of prices. Rising peaks and troughs constitute an up trend; falling peaks and troughs constitute a downtrend that determines the steepness of the current trend. The breaking of a trend line usually signals a trend reversal. Horizontal peaks and troughs characterize a trading range.
Moving averages are used to smooth price information in order to confirm trends and support and resistance levels. They are also useful in deciding on a trading strategy, particularly in futures trading or a market with a strong up or down trend.
The most common technical tools:
Coppock Curve is an investment tool used in technical analysis for predicting bear market lows.
DMI (Directional Movement Indicator) is a popular technical indicator used to determine whether or not a currency pair is trending.
Unlike the fundamental analyst, the technical analyst is not much concerned with any of the "bigger picture" factors affecting the market, but concentrates on the activity of that instrument's market.Fundamental analysis
Fundamental analysis is a method of forecasting the future price movements of a financial instrument based on economic, political, environmental and other relevant factors and statistics that will affect the basic supply and demand of whatever underlies the financial instrument. In practice, many market players use technical analysis in conjunction with fundamental analysis to determine their trading strategy. One major advantage of technical analysis is that experienced analysts can follow many markets and market instruments, whereas the fundamental analyst needs to know a particular market intimately. Fundamental analysis focuses on what ought to happen in a market. Factors involved in price analysis: Supply and demand, seasonal cycles, weather and government policy.
The fundamentalist studies the cause of market movement, while the technician studies the effect. Fundamental analysis is a macro or strategic assessment of where a currency should be trading based on any criteria but the movement of the currency's price itself. These criteria often include the economic condition of the country that the currency represents, monetary policy, and other "fundamental" elements.
Many profitable trades are made moments prior to or shortly after major economic announcements.

Choosing a Broker There are many forex brokers to choose from, just as in any other market. Here are some things to look for:
Low Spreads - The spread, calculated in "pips", is the difference between the price at which a currency can be purchased and the price at which it can be sold at any given point in time. Forex brokers don't charge a commission, so this difference is how they make money. In comparing brokers, you will find that the difference in spreads in forex is as great as the difference in commissions in the stock arena. Bottom line: Lower spreads save you money!
Quality Institution - Unlike equity brokers, forex brokers are usually tied to large banks or lending institutions because of the large amounts of capital required (leverage they need to provide). Also, forex brokers should be registered with the Futures Commission Merchant (FCM) and regulated by the Commodity Futures Trading Commission (CFTC). You can find this and other financial information and statistics about a forex brokerage on its website or on the website of its parent company. Bottom line: Make sure your broker is backed by a reliable institution!
Extensive Tools and Research - Forex brokers offer many different trading platforms for their clients - just like brokers in other markets. These trading platforms often feature real-time charts, technical analysis tools, real-time news and data, and even support for trading systems. Before committing to any broker, be sure to request free trials to test different trading platforms. Brokers usually also provide technical and fundamental commentaries, economic calendars and other research. Bottom line: Find a broker who will give you what you need to succeed!

The Need for a Structured Trading MethodSuccess in Forex requires a systematic way of making trading decisions. I have traded Forex for 25 years, first as a bank trader, and later as an independent trader with my own trading portfolio. As an independent trader I have had to develop methods to manage my market exposure and control my trading risk without the support of a trading team.These two challenges led me to Technical Analysis -- the study of the relationship of indicator and/or price patterns and price movement. A basic premise of T.A. is that "history repeats itself". Most technical analysts look for repetitive price or indicator patterns on currency price charts. Patterns that anticipate price movement. The assumption is that when a recognized, repetitive pattern appears it will likely precede a certain associated price movement, thus giving the trader the information he/she needs to place a successful trade. With Technical Analysis I began to develop an objective method for getting into and out of currency positions.To consistently make money in the Forex market you want to have a set of trading rules that you follow. This will separate you from the market gamblers and give you the structure to become a professional trader.Without a set of trading rules it is difficult to repeat successful trades on a consistent basis. If you can identify market conditions associated with winning trades, find a way to describe them, and quantify and test out your theories then you will have the opportunity to build on your previous success.

The Purpose of Forex trading. The purpose of trading on any market is to buy low and sell high. The foreign currency market FOREX is no exception. The goods traded on this market are rates of currencies of different countries. As any other goods the currencies have their prices.

To settle transactions between businesses located in different countries, governments, speculative transactions and so forth, banks around the world execute currency trades on FOREX market. Depending on various trade, economical and other parameters, interest rates, central bank policies, time of the day, preferences and anticipations of the market players, and many other causes, the rates, that is prices, of currencies stay in ceaseless motion.

Your task as a trader is to determine the trend of the rate and buy an appreciating currency or sell a depreciating one, and then take your profits through execution of a reverse transaction.

Our dealing center gives you the opportunity to use software to obtain real time currency quotations from different banks and largest world exchanges participating in FOREX market. At the same time, the rate charts for every currency are displayed for you, and hottest economical News that may affect currency rates now or in the future directly or indirectly are fed to your screen.

And, at last, you will have a special trading account allowing you to buy and sell desired currencies. Despite of having US dollars in your account, you may start your trading from selling japanese yens not concerning yourself with not having bought them in advance.

Some codes, numbers and definitions.

Each currency is assigned a three-letter code. For example, US dollar is coded - USD (United States Dollar), euro is coded EUR (EURo), Swiss frank is coded CHF (Confederation Helvetica Franc), Japanese yen is coded JPY (JaPanese Yen), British pound is coded GBP (Great British Pound). Currency rates are equal to ratios of currency units of different countries relative to each other. The rates are represented by 6-letter words composed of two three-letter currency codes. The first position is occupied, as a rule, by the code of a more expensive currency. The rates are expressed in units of the second currency per unit of the first one. For example, rates USDCHF (USD-CHF) show the number of Swiss franks in one US dollar, but rates GBPUSD (GBP-USD) show the number of US dollars having to be paid for one British pound.

The rates are usually expressed as five-digit numbers. For example, USDJPY = 121.44 means that 1 US dollar is valued at 121.44 Japanese yens (i.e. they are willing to pay you that many yens for one US dollar while you are buying or selling). At the same time, GBPUSD = 1.6262 means that 1 British pound is valued at 1.6262 US dollars. Generally, if the rate XXXYYY = Z, it means that one unit of XXX is worth Z units of YYY.

When the rate has changed, for example USDJPY = 121.44 to USDJPY = 121.45 or GBPUSD = 1.6262 to 1.6263, they say that the rate has moved 1 point. As it follows from the information above, yen in this example has DEPRECIATED by 1 point, but the pound has APPRECIATED, also by 1 point.

While watching the charts, you should keep in mind that only euro (EURUSD) and British pound (GBPUSD) charts reflect real movements of the rates of these currencies (that is, chart going up, means increasing price), as growth (that is, charts moving up) mean decreasing rates (prices) for the other currencies.

Your trading account is kept in US dollars, this is why it would help to know the worth of this 1 point expressed in other currencies. The point's worth is determined by the following algorithm: you should divide the size of a lot by the rate disregarding the position of the decimal point. For example, in the example above the worth of one point USDJPY expressed in US dollars = 100000 / 12144 = $8.24. Or, for GBPUSD one point's worth = 100000 / 16262 =$6.15. Consequently, the worth of one point is different not only for different currencies, but also for the same currency in different quotations.

It is known, that every transaction is executed at a rather well defined and concrete price, while the table Quote Spread Sheet lists three prices for each currency, for example:


Each of the participants of FOREX market enters each trade as either a SELLER or a BYUER of a particular currency. In so doing, the seller offers the currency at a higher price, for example GBPUSD at 1.6325, while the buyer bids for it at a lower price, for example, GBPUSD at 1.6322. The seller's price is called ASK and the buyers price is called BID accordingly. This is why, if you anticipate GBPUSD to appreciate (your GBPUSD chart to go up), then you should decide to buy the pound when it is low to sell it high later. You can BUY only from a seller offering it at the price equal to ASK. Should you be selling the pound (this operation is called SELL), the buyer will bid at a price equal to BID for it (this holds true for all currencies). The obvious conclusion is that if you have OPENED a !! position (the operation is called OPEN), that is you have executed BUY GBPUSD, and want to CLOSE it immediately (the operation is called CLOSE), that is to sell the pounds you have just bought, then you could do it only at a loss, similar to what would happen at any currency exchange booth. Consequently, to make a profit you should let the rate move in the anticipated direction more than the difference between BID and ASK. The third number is called LAST, which is an average of last BID and ASK on Forex.

To sum up, for USDCHF and USDJPY OPENING of a SHORT position (that is BUY) is executed at the BID price, and the CLOSING at the ASK price respectively; correspondingly OPENING of a LONG position (that is SELL) is executed at the ASK price, and CLOSING at the BID price.

For GBPUSD and EURUSD OPEN BUY (up) occurs at the ASK, ànd CLOSE at the BID, while OPEN SELL (down) happens at the BID, ànd CLOSE at the ASK.

Let us get acquainted with some useful trading tools allowing us to protect ourselves from unforeseen losses to certain degree and take the expected profits.

These are STOP and LIMIT. For a previously opened position an instruction may be entered at any moment (during the working days) to close it, if the rate reaches a preset level. For example, you have opened a position expecting the rate to go up (on the chart). To protect yourself from significant losses if the rate moves down, especially in such a situation when you don't have or are about to lose control of the market, you should enter a STOP, that is set a price at below its current value at which your position should be closed with no further instructions. Similarly, if you have opened a down position, then you should specify a price above its current value. In this case you should bear in mind that if the STOP is set too closely to the current rate value, then a random rate fluctuation may close a correctly open position at a loss, but if it is set too far, then the losses could become unreasonably high. LIMIT is a rate value that you set at which the position should be closed with a profit, that is the value of the LIMIT should always be above the current level, if you play long, and below it, if you play short. It should be noted that STOP and LIMIT should differ by more than 20 points from the current values of BID or ASK (in accordance with what side of the market you play and which of these tools you use).

A few more words about the differences between operations and service in a training and a real trading accounts.

In the quoting mode of a training account real quoting does not occur, and the offered price corresponds to slightly modified BID/ASK ratio (depending on whether you play long or short). Naturally, with a real account the offered price does not usually coincide with the value of BID/ASK (the difference is 1-2-3 points in a calm market, more often than not it's not in your favor).

The time lag between a rate inquiry and the receipt of a quotation (about 10 s) in a training account simulates the real-life lag rather well (usually 40-50 s, sometimes longer). It should be kept in mind, though, that the quoted rate is equal to the rate at the moment of quoting, rather than the moment of inquiry.

An overview of the Forex market

An overview of the Forex marketThe Forex market is a non-stop cash market where currencies of nations are traded, typically via brokers. Foreign currencies are constantly and simultaneously bought and sold across local and global markets and traders' investments increase or decrease in value based upon currency movements. Foreign exchange market conditions can change at any time in response to real-time events.
The main enticements of currency dealing to private investors and attractions for short-term Forex trading are:
24-hour trading, 5 days a week with non-stop access to global Forex dealers.
An enormous liquid market making it easy to trade most currencies.
Volatile markets offering profit opportunities.
Standard instruments for controlling risk exposure.
The ability to profit in rising or falling markets.
Leveraged trading with low margin requirements.
Many options for zero commission trading.
Forex tradingThe investor's goal in Forex trading is to profit from foreign currency movements. Forex trading or currency trading is always done in currency pairs. For example, the exchange rate of EUR/USD on Aug 26th, 2003 was 1.0857. This number is also referred to as a "Forex rate" or just "rate" for short. If the investor had bought 1000 euros on that date, he would have paid 1085.70 U.S. dollars. One year later, the Forex rate was 1.2083, which means that the value of the euro (the numerator of the EUR/USD ratio) increased in relation to the U.S. dollar. The investor could now sell the 1000 euros in order to receive 1208.30 dollars. Therefore, the investor would have USD 122.60 more than what he had started one year earlier. However, to know if the investor made a good investment, one needs to compare this investment option to alternative investments. At the very minimum, the return on investment (ROI) should be compared to the return on a "risk-free" investment. One example of a risk-free investment is long-term U.S. government bonds since there is practically no chance for a default, i.e. the U.S. government going bankrupt or being unable or unwilling to pay its debt obligation.
When trading currencies, trade only when you expect the currency you are buying to increase in value relative to the currency you are selling. If the currency you are buying does increase in value, you must sell back the other currency in order to lock in a profit. An open trade (also called an open position) is a trade in which a trader has bought or sold a particular currency pair and has not yet sold or bought back the equivalent amount to close the position.
However, it is estimated that anywhere from 70%-90% of the FX market is speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency.