Forex forecasting helps a trader predict price movements in the highly volatile forex market. The trader can forecast market behavior either through technical analysis or through fundamental analysis, though some traders use a mixture of both to get the best results.
Fundamental analysis is used to forecast future price movements. It uses economic, political, environmental and other relevant data that can impact the supply and demand of a financial instrument. This type of analyst has to be well versed with the market as he has to strategically assess where a currency should be trading based on external factors – which are always unpredictable -- and not on the current price of a currency.
Technical analysis uses the past market action to create charts that can be used to forecast market movements. Thus, it is strictly based on facts rather than hypothetical analysis. One major advantage of technical analysis is that experienced analysts can follow many markets and market instruments simultaneously. It is based on the following three principles:
1. The actual price is a reflection of factors known to the market. There are therefore no surprises, and the analysis is based on actual price movements.
2. Market behavior shows distinct patterns. The technical analyst therefore looks for these patterns knowing that when the patterns repeat the results will be the same.
3. Forex patterns reflect human psychology. Historically, they show that humans behave in the same manner.
Technical analysts use five distinct theories to make the forecasts. These are: indicators (oscillators such as Relative Strength Index theory), number theory (Fibonacci numbers, Gann numbers), Waves (Elliott wave theory), Gaps (high-low, open-closing theory) and Trends (following the moving average theory).
However, irrespective of the method used a great deal of data goes into making a forecast. The developments of new software tools, and availability of historical data, have made forex movements more precise. There is also a greater stress on analysis now as compared to the past, when the traders went by gut feeling.