In Forex Trading, there are two main approaches – Fundamental Analysis and Technical Analysis. Fundamental analysts will concentrate on the underlying causes of price movements, whereas as technical chartist studies the actual price movement.
Fundamental analyst focus on various macroeconomic indicators - Interest Rate, Trade Balances, Growth Rates, and Unemployment rates, Gross Domestic Product (GDP), Inflation and etc. For beginners, do take note that there is no single set of rule to trade Forex using fundamental analysis. There are many theories on how a currency should be valued.
Technical analyst used historical price data to forecast the direction of future price movement. Technical analysis work on the premise that all current market information is already reflected in the price and that studying price action alone is more than necessary to trade the market.
Some popular methods of technical analysis include, Chart Pattern, Japanese Candlestick Pattern, Trend line, Support and Resistance Line, Pivot points, Fibonacci Retracement and Elliott wave theory. Technical Indicators which utilize mathematical or quantitative tools are Moving Averages, Bollinger Band, Average True Range, Stochastic Oscillators, Fibonacci Retracement, Commodity Channel Index, Convergence and Divergence of Moving Averages (MACD) and Relative Strength Index (RSI).
After understanding these two widely known methods of analysis available, you could be more or less able to tell which methodology suits you most. If you are very financial incline type of person, fundamental analysis may be your forte.
In Forex trading, traders tend to rely more on technical analysis to make informed decision on future price movement.
Most seasoned trader after years of trading tend to develop their own trading system or methodology. The system could be a combination of certain technical indicators which they are very comfortable with. It is only when a trader is very comfortable with his system that he will trade it wholeheartedly and confidently.
For others, they may decide to trade someone else’s system.
Regardless of whatever approaches you use – be it fundamental analysis or technical analysis, the system or method must be profitable and nothing else matter.
For many traders, they think that the best way to find out whether a system or method is profitable is through back testing. However, back testing has its disadvantage is that it can never fully duplicate live market conditions. What is obvious setup may not be so obvious in real time.
A better alternative is by forward testing trading your system in real-time with a demo account. Forward testing will give you a better and clearer understanding of what your system is capable of. In Forex trading, live demo account is so widely and easily available and trades just like a real account. It is an excellent way to evaluate the profitability of a system.
For a system to be profitable, we also need to know about expectancy and opportunity.
Basically, expectancy will tell a trader what you can expect to make (win or lose) for every dollar risked. The expectancy formula is as follows:
Expectancy = (Probability of winning Ч average win) – (Probability of losing Ч average loss).
It will produce a figure which is the average amount you can expect to profit per trade. If the expectancy is negative, it means that the system or method can’t generate profit. And obviously, the higher the expectancy is the better.
After expectancy, we will have to look at the opportunity factor. Opportunity simply means the number of opportunity you are able to trade with your system or method. By multiplying expectancy with opportunity, a trader will know how much you can make with your system or method over a period of time. For obvious reason, if the system’s expectancy is positive and offers plentiful of trading opportunities, it will means more profit.
Now, we have come to the most important aspect of Trading – Money Management. 90% of traders failed in Forex Trading mainly because of they don’t understand the important of money management. Money management will inform you how much you should risk per trade. The main focus of money management is the preservation of trading capital to ensure your survival over the long term. The most common method of money management is the percent risk model. It will tell a trader not to risk more than how many percent of your trading account balance on any one trade. Generally, a range of between 1-3% is acceptable percentage to use in order to make money in the long term. Just imagine if a trader has a risk exposure of 20% per trade, few straight losses in a row will wipe out the entire account.
After reading the above factors, you will be more or less able to know which approaches suits you.