When it comes to trading currency pairs, every professional trader has a plan, a method to simplify trading and predict future prices.
When it comes to trading currency pairs, every professional trader has a plan, a method to simplify trading and predict future prices.
Forecasting helps traders better plan their trades and trade their plans, and what’s more, if you get good at making predictions on currency pairs, you can turn it into a career. Some financial analysts get really wealthy without investing a single penny of their own capital.
Trading rules and forecasting methods should be clear, easy to understand, and easy to follow. What’s more, every trader and analyst has their own rules for forecasting a currency pair’s performance. In this article, we’ll focus on Forex forecasting methods, what they are and how professional traders use them.
There are two general methods traders and analysts use to predict future prices: technical analysis and fundamental analysis. In addition, there are traders that use both methods at the same time.
Most Forex traders use technical analysis to make forecasts. Technical analysts study how a given trading instrument has been performing, seek price patterns, and predict that things that happened many times before, will happen again.
The biggest flaw of technical analysis is that it doesn’t include fundamentals such as economic and political news. In addition, markets are dynamic. Things change often and technical analysis is bad at coping with changes. This is why many traders use both technical and fundamental analysis.
Technical Forex traders use indicators, chart patterns, candlestick patterns, support and resistance levels, and psychological levels (that are created around round price points) to make price predictions.
In the example of the Euro vs US Dollar, analysis uses trendlines to determine support and resistance points. The pair is traded in a downtrend, and indeed the price seems to be respecting the trendlines. When making a forecast, analysts usually discuss both bullish and bearish scenarios. If the price keeps respecting the resistance trendline, the price will keep going down. If the brice breaks the resistance and closes over the 1.00000 (psychological price) can become a new support for an uptrend.
Such forecasts help traders to keep trading based on technical information no matter where the price goes. In both scenarios, trades can be entered around breakout points, which results in great risk to reward ratios.
As you can see from this example, for technical traders, it’s not important to know exactly where the price will go next. The most important thing is to find good risk to reward ratios. So that even if traders are correct 50% of the time, they’ll be able to grow their account as winnings will be larger than losses.
Forecasting is only a single dimension for trading profitably. Traders need to manage their risks, emotions, time, balance personal and work life, have proper account balance and not be dependent on income from trading.
In technical analysis patterns are actively used to forecast future performance. Patterns are certain shapes and formations that price repeats frequently on the charts. FX Chartists study these patterns and base their prediction on the belief that what has happened many times before, will likely happen again. As you can see, there’s nothing guaranteed. The key to profitable trading long term is to have probabilities on your side, in other words, have a trading edge. And to only risk a small percentage of your capital per trade so that you will not be out of business even if a trade (or series of trades) goes against your predictions.
There are two types of patterns: chart patterns and candlestick patterns. What’s more, patterns that predict the price to reverse are called reversal patterns. And patterns that predict the price to continue are called continuation patterns. In addition, there are patterns that signal indecision which means that price might go in any direction.
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Candlestick patterns are only available if you are using Japanese candlesticks as your charting method.
In this example, you can see a Symmetrical Triangle chart pattern. The pattern can be found in both bullish and bearish trends. The pattern helps trends continue. To trade the pattern, the trader needs to wait for the completion and place order after the reacout candle closes outside the support. Expected profit target is at least the same size as the largest distance between the two trendlines.
In addition to the Support and Resistance trendlines, chart and candlestick pattern and psychological levels, technical traders use indicators.
Keep in mind that market conditions often change. Trend following indicators such as moving average indicators fail to perform in ranges. For range trading, stochastic oscillators are developed. It’s important to learn how to use different indicators for forecasting different market conditions.
As you can see, there are a lot of methods, patterns and indicators to conduct technical analysis. Which is why trading can become complicated and stressful. Good trading should be effortless. Which means it’s best to learn everything that you can about trading, pick trading strategies that make the most sense to you and trade them. Traders that use a bunch of methods and indicators, end up paralysed. Often one indicator tells them to buy and another tells them to sell. In trading, when a trader is unable to make a decision as there’s too much contradicting information, it’s called analysis paralysis.
Fundamental analysis is actively used in forecasting the Forex market. Fundamental analysts study current political and economic events such as trade deficit, unemployment, interest rate decisions, inflation, building permits, manufacturing, etc. In other words, fundamental traders study what is currently happening on the market. Fundamental reasons move the markets. And markets move based on technical frames. That is why it’s highly important to learn about both in order to be able to make forecasts on currency pairs.
In fundamental analysis one of the most important factors that can help traders predict future valuation is interest rates. When inflation becomes too great, central banks limit the money supply on the markets. The main job of central banks is to keep inflation in check. Raising interest rates means that bank loans become more expensive. As a result, people will take out less loans, the amount of money will decrease in the market and the inflation will stabilize. That’s how analysts think when they are forecasting the Forex markets. The degree to which fundamentals can affect the value of any given currency depends on how strong these fundamentals are.
Understanding Forex Forecasting using fundamentals can become challenging if you are making predictions on exotic pairs. Exotic currencies come from developing countries and there’s very little information that can be trusted available for traders. As for the major currencies, keep in mind that many currencies, including majors are correlated. Some currencies are correlated with each other, for instance Euro and CHF are highly correlated and no wonder, the Swiss economy and Europe have many things in common. You need to take such things into account when making a prediction. What’s more, there are currencies that are highly dependent on commodity prices, such as Canadian Dollar, New Zealand Dollar and Australian Dollar. All of the three countries are producing commodities for the world. For instance, oil prices affect the value of the Canadian Dollar because Canada is one of the largest exporters of oil.
In addition to economic reasons, political turmoil within a country and difficulties between two countries can damage their currencies. Trade wars and military conflicts are also damaging currencies.
As already mentioned, guessing where the price will go is not important. Even the best traders make mistakes when they are forecasting the FX market. However, successful traders manage to have greater winners to cover the losses to stay profitable. The key success in trading is having an edge. If you can’t take losing money, then position trading and making sure that your predictions are precise is important. If you don’t care about the number of losses and your main goal is to grow your account, it’s important to find setups with good risk to reward ratios that will enable you to cover the losses.
To sum everything up, understanding Forex forecasting is important for traders as it helps them plan their trades and trade their plans. What’s more, analysts that are good at making predictions can make it into a career. There are two major Forex forecasting methods that traders use: technical analysis and fundamental analysis. Technical analysis studies past currency pair performance using candlestick patterns, chart patterns, technical indicators, and support and resistance trendlines. Fundamental analysis studies technical and political events and bases its prediction on current events rather than the past. There are traders that use both methods simultaneously. However, it’s important to keep trading simple to avoid stress and analysis paralysis.
There are two major methods two forecasting currency prices: technical and fundamental analysis. Technical analysis uses patterns, indicators and trendlines to make predictions based on past performance. Fundamental analysis studies current political and economic events.
Yes. The key to success is not to be correct all the time. In fact, most successful traders are correct only 50% of the time. The key to success is to have an edge and have bigger winners to cover the losses and grow your account. The second way to grow your account is to have a higher win rate, therefore, even if the risk to reward ratio is 1:1, more winning trades grow your balance.
No. At least try to understand the reason behind their thinking. You cannot find a professional trader that makes consistent profits and waits for other people’s opinion to make a trade. Outside opinion is highly valuable when it makes sense. Following an analyst blindly might result in losing trades as each trader is different and what works for others might not work for you.