What is a trading strategy based on?
A trading system may be based on any of the three following trading concepts:
- Sentiment analysis
- Fundamental analysis
- Technical analysis
Sentiment analysis tries to gauge the sentiment of the traders in the market. Most sentiment traders rely on their long trading experience, or their “gut feeling”. They say that they “feel” the next move of the market. That comes after many screen hours in front of the price charts.
The lack of solid trading rules makes this concept restricted only to very experienced traders. It’s an extremely risky method, and traders are prone to lose their discipline with it.
Fundamental analysts study the economic, political and environmental factors that affect the price of their financial instrument. For example, a high interest monetary policy might see the corresponding currency surge higher. On the other hand, an unstable political system could see the corresponding currency decline.
Fundamental analysts are interested in the intrinsic value of their instrument. In other words, the price where the financial instrument should be trading at. If the price is trading higher than the intrinsic value, then it’s considered overpriced. If it’s trading lower than the intrinsic value, then it’s considered underpriced.
The third type of analysis is technical analysis. This is the study of market action primarily through price charts, to identify the next trend as early as possible.
Technical analysis itself can be branched off into three principles:
- Market action discounts everything - This means that all information, including fundamental analysis, is reflected on the price charts.
- Prices move in trends – Meaning there are obvious trends on the charts, even if the markets move sideways and don’t trend 100% of the time.
- History repeats itself - That is, chart patterns that performed well in the past, are expected to work equally well today and into the future.
Which concept is good for you to use in your trading system? The answer is simple: the one you are most comfortable with!
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Risk Warning: There is a high level of risk involved with trading leveraged products such as forex and CFDs. You should not risk more than you can afford to lose, it is possible that you may lose more than your initial investment. You should not trade unless you fully understand the true extent of your exposure to the risk of loss. When trading, you must always take into consideration your level of experience. If the risks involved seem unclear to you, please seek independent financial advice.