The two primary approaches of analyzing the forex market are fundamental analysis and technical analysis. Fundamentals focus on financial and economic theories, as well as political developments to determine forces of supply and demand. One clear point of distinction between fundamental and technical is that fundamental analysis studies the causes of market movements, while technical analysis studies the effects of market movements.
Technical analysis is a technique used to forecast the future direction of prices through the study of historical market data, primarily price, volume and open interest. Technical traders use trading information (such as previous prices and trading volume) along with mathematical indicators to make their trading decisions. This information is usually displayed on a graphical chart updated in real time that is interpreted in order to determine when to buy and when to sell a specific instrument.
The oldest Dow Theory in technical analysis states that prices fully reflect all existing information. Knowledge available to participants (traders, analysts, portfolio managers, market strategists and investors) is already discounted in the price action. Movements caused by unpredictable events such as acts of god will be contained within the overall trend. Technical analysis aims at studying price action to draw conclusions on future moves.
There are many large players in the forex market, such as hedge funds and banks, that all have advanced computer systems to constantly monitor any inconsistencies between the different currency pairs. Many traders turn to forex technical analysis because it presumes that all the factors that influence a price - economic, political, social and psychological - have already been factored into the current exchange rate by the market.
Technical traders use many different indicators in combination with support and resistance to aid them in predicting the future direction of exchange rates. A few indicators that we feel we should mention due to their popularity are: Bollinger Bands, Fibonacci retracement, moving averages, moving average convergence divergence (MACD) and stochastic. These technical tools are rarely used by themselves to generate signals, but rather in conjunction with other indicators and chart patterns.