How Traders Analyze the Market
All right, we have gone through the boring but necessary basics of forex. Now is the time to step up the pace and start learning how to spot where the profits are hiding.
There are two main types of analysis that traders use to read the market and develop trading strategies:
Fundamental analysis – looks at economic, political and social factors.
Technical analysis – studies the charts to spot patterns.
Traders have been and are still debating which analysis is the best. In reality, you will need to understand both in order to become a forex guru. There are many traders focusing just on technical analysis, but you have to understand the following rule:
What you see on the charts didn’t appear there by chance. It is there by a fundamental reason!
A balanced approach is to use fundamental analysis to determine the underlying trend in a currency rate and then use the technical analysis to pinpoint the exact entry and exit points for a trade.
Fundamental analysis
Fundamental analysis looks at the economic strength of countries, which is influenced by monetary, political and social forces. The better the current and future economic outlook for a country, the more foreign businesses and investors will invest resources into it. By investing, they are creating demand for the country’s currency as they are converting their currency and buying local currency.
And here comes one of the most fundamental currency price rules: the higher the demand for a currency, the higher its value!
Do you remember Erik from the Introduction?
The one who lost 450,000 euro in one day because the Swiss franc skyrocketed by 30%? (The event, by the way, is also known as the Francogeddon.)
If Eric had known and considered this rule before taking the loan from a Swiss bank, he would not have suffered that loss!
This supply-demand rule may seem obvious, but the fun is not about the rule itself, but about the factors influencing it. So let’s break it down so you understand how it works and identify the elements that created
Franc is prone to appreciate
Switzerland has long been the place that attracts rich people and their money. It is considered a safe haven due to the low inflation and its banks have a great reputation for being secure. All this contributes to high demand for the Swiss franc, so its value is constantly prone to increase. This is good if you keep your capital in francs for it is bound to grow in value. However, it is not good if you get a loan in francs and your income is in euro as in Erik’s case, especially in times when the euro value is expected to decrease. Even if Erik was not aware of the upcoming euro devaluation, he should have been skeptical about getting this loan due to the rising nature of the franc.
Millionaires from Russia
Because of the heated situation between Russia and Ukraine and the falling ruble, even more Russian millionaires poured their money into Swiss banks. This created greater upward pressure on the franc.
Money injections in EU
In order to boost the sluggish Eurozone’s economy, the European central bank was planning to inject huge amounts of money into the economy, which would significantly decrease the value of euro. A depreciating euro means that Erik’s hard-earned money will buy less Swiss francs so it will be more expensive to repay the loan.
The artificial ceiling
Before the Francogeddon, the Swiss franc was pegged to euro to protect Swiss exporters. In order to maintain the peg, the Swiss National Bank (SNB) artificially fixed the franc to euro by aggressively buying huge amounts of euro with francs. By reducing the supply of euro and increasing the supply of francs, it depreciated the franc against the euro.
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