Fundamental Analysis
Stepping away from the charts and considering the context in which a currency pair trades is the domain of fundamental analysis (FA). FA takes into consideration a pair’s political, economic and regulatory environments. This means looking at the countries involved.
The political environment is always a concern. If there is unrest in a country and the chance of some type of revolt is high, the currency is probably already decreasing in price. If everything clears up, it could mean big gains for the country’s currency. Understanding such factors requires knowledge about the country’s current political state.
The political environment is always a concern. If there is unrest in a country and the chance of some type of revolt is high, the currency is probably already decreasing in price. If everything clears up, it could mean big gains for the country’s currency. Understanding such factors requires knowledge about the country’s current political state.
Economic and regulatory factors also come into play for any currency. Is the central bank ready to raise rates? Is the country about to go into recession? Are trade tariffs hindering the country’s ability to equally compete on the world stage?
The legal or regulatory environment is also a concern. New laws and regulations can affect commerce within a country. Such laws can also be closely related to any tariff action. Having people within the country who understand it best is a major advantage over competitors when it comes to forex trading.
Quantitative Analysis
Quantitative analysis (QA) makes use of charts to determine patterns that may have some predictive value. There is almost an endless number of techniques that can be employed when it comes to QA.
One popular QA method is the use of moving averages. Moving averages provide a pattern for how a pair moves based on a selected time frame. For longer-term investors, this time frame will be based on weeks, months and potentially years.
Multiple moving averages are often employed. For example, 20-day, 50-day, and 200-day moving averages are common. The lower the number, the more sensitive the moving average. A 20-day moving average will look more volatile than a 200-day moving average. By employing all three moving averages, you get a picture of an overall price trend.
Other forms of QA use support and resistance levels. This involves understanding where the price has had a difficult time moving higher or lower. Once price breaks above some formidable number, it can lead to still higher prices. Being prepared for such breaks can prove lucrative. Breaking through a level doesn’t mean the currency will always run. That’s where having a plan comes into play, which we’ll discuss soon.
Spot Forex Pricing Models
Pricing models are tried and tested models that a team has developed over months or even years. After the first few months, much of the heavy development into such models abides. From then on, it’s only a matter of tweaking the model. Pricing models can help in predicting a currency pairs price movements.
If pricing models are great at predicting price movements, why not use them all the time? The main reason is that pricing model is usually designed for specific situations and work well only in those situations. It’s the experience and skillset of the team that is required to recognize a situation in real-time and employs the correct pricing model.
Pricing models are part of a more comprehensive plan referred to as an investment strategy.
Investment Strategy
An investment strategy is a plan that focuses on a specific currency pair scenario. For example, a volatile country that is on the verge of collapse might utilize one investment strategy while a country that is booming will use another investment strategy.
Investment strategies use specific pricing models designed for the strategy and also determine position sizing and overall portfolio allocation for the strategy. If a strategy is risky, a smaller amount of the portfolio will be allocated to the strategy than that of a less risky strategy.
A portfolio can be made up of multiple investment strategies. How much of a portfolio to dedicate to a particular strategy is a personal decision and greatly depends on the strategies already being utilized.