There are two main approaches to analyzing and investing in the currency market. Both of them have distinct similarities to their counterparts in the equity markets. They are known as technical analysis and fundamental analysis. The technical analyst looks only at price movements as a way to predict future movements, while the fundamentalist tries to discern the underlying cause of the movements.
Technical Analysis
A Technical Analyst, or a technician, looks at the movement of a currency over a previous time frame. By looking at movements and patterns, up and down, the analyst can see things like levels of support, breakout levels, or trends. He may not know, or care to know, the rationale behind these movements, but one does not need to needlessly know why a holding goes up, they only need to know that it does go up.
Fundamental Analysis
On the opposite spectrum is fundamental analysis. This is where the analyst studies things like wars, discoveries, governmental activities, regulations, and other factors that influence the value of a currency. This can include growth or deflation of a country, inflation, stability. or several other factors, each of which needs to be weighed against the other.
The analyst looks at macroeconomic factors, indicators, asset markets, and geopolitical considerations, and evaluates the value of one nation's currency against another. They look at indicators such as Gross Domestic Product (GDP), interest rates, inflation rates, unemployment rates, money supply, productivity, and other items. They look at stock, bond and real estate markets, and look for a stable government.
Sometimes, governments can step in when they do not like what a currency is doing, either propping its value up, or devaluing it, depending on their goals. Some large countries can even move the value of their currency purely by suggesting that they will take action, even when they do not.
So which path should you take? It truly depends on your level of comfort. Technical analysis is easier to study, as once you master how to read charts, you will be able to analyze any currency, over any time frame. Fundamental analysis is harder, as it takes a deep understanding of complex factors, and changes constantly. However, the more you understand what you are buying and why, the better off you will usually be.
