Lesson 1: Three Types of Market Analysis

You’re probably tired of hearing that trading in the forex markets is very risky. But risks are such an integral part of the financial markets that it’s worth stating repeatedly. 

You may wonder, “If forex trading is so uncertain, how does anyone make money consistently?” 

The answer lies in market analysis. 

In this lesson, you’ll learn about market analysis, the three analysis techniques, and their importance. 

Lesson Highlights

• Market analysis helps traders predict how markets will likely behave in the future. 
• There are three types of market analysis: technical, fundamental, and sentiment analysis. 
• Technical analysis relies on historical data, such as price movements and trade volume. 
• Fundamental analysis uses economic indicators, such as a country’s inflation and interest rates. 
• Sentiment analysis gauges the overall “mood” of traders and how it can affect the market. 
• Some analysts argue that sentiment analysis is just a subcategory of fundamental analysis. 

What is Market Analysis? 

Market analysis is the practice of using various factors (e.g., historical market data and economic indicators) to determine the potential future movements and trends within a particular market. 

Traders often employ market analysis to help them determine the best course to take with their trades. Depending on the results of their analyses, a trader may go long, short, open, or close a position. 

Analyzing how markets move and respond to different factors can help you identify profit opportunities, reduce or completely mitigate losses, and better manage trading risks. 

There are three primary types of market analysis: 

• Technical analysis 
• Fundamental analysis 
• Sentiment analysis 

No method is superior to the others, and many market analysts often use a combination of the three to get a better “reading” of the market. 

Technical Analysis 

Technical analysis is a way of determining future market trends and movements using technical indicators. These indicators include historical price data and tools for measuring or “squeezing out” patterns from them. 

Examples of popular technical indicators include: 

• Bollinger Bands 
• Fibonacci retracement 
• Simple moving averages (SMAs) 
• Exponential moving averages (EMAs) 
• Chart patterns 

These indicators all rely on past market data. 

Fundamental Analysis 

In contrast with technical analysis, fundamental market analysis relies on external data that can affect market movements. These data are called economic indicators. 

Some examples of economic indicators are: 

• Geopolitical events (e.g., wars, elections, sanctions, trade disputes) 
• Central bank events 
• GDP growth 
• Employment rate 
• Interest rates 

These economic determinants influence the value of the currencies of the relevant countries. As forex trading works with currency pairs, events that impact one currency can either strengthen or weaken the other. 

Sentiment Analysis 

Sentiment analysis, also known as market sentiment analysis, is a method that attempts to determine how markets will potentially behave in the future based on the market participants’ overall “mood.” 

For instance, a trader using sentiment analysis may look at economic news reports and execute trades depending on how they feel the market would react to these reports. 

Fundamental vs. Sentiment Analysis 

Some analysts classify sentiment analysis as a subset of fundamental analysis. They argue that it shouldn’t be treated as a separate approach. 

However, there are distinctions between the two techniques. Fundamental analysis’ focus lies on the overall economic health of a particular territory. On the other hand, sentiment analysis focuses on how traders would react to the factors used in fundamental analysis. 

Think of a patient receiving a medical diagnosis. Fundamental analysts would base their moves on the analysis given by the doctor. Meanwhile, sentiment analysts would use the reactions of the patients and their loved ones to make trading decisions. 

In the next lessons, you’ll read about the three approaches to market analysis in more detail.