Introduction to analysing foreign currencies

by David du Plessis | December 13, 2022

excgange-rates

Whether you are an importer or exporter, it is crucial that you evaluate your business’s sensitivity to fluctuating exchange rates and develop a comprehensive risk management policy to fit your company’s needs. An effective foreign currency risk management strategy allows a business to optimize results, while minimizing the losses that occur as a result of foreign exchange fluctuations. In order to receive the utmost benefit, this risk management policy will need to be applied consistently and effectively.

How does WauTreasury do this? We specialize in creating tailored foreign exchange risk management policies. By using internal and historical data, combined with technical and fundamental analysis, our team is able to create a policy to fit your company’s needs.

Having a proper foreign currency risk management plan in place can make for more controlled, profitable and less stressful currency trading. In this article, we dive into how technical and fundamental analysis play a role in optimising forex risk management.

The fundamental factors shape sentiment of currencies, while technical analysis helps us visualize that sentiment. Fundamental analysis involves reviewing economic data and news headlines, while technical analysis involves reviewing charts to identify price action or trends over certain time frames.

Fundamental Analysis

Fundamental analysis refers to the examination of the basic factors which influence a currency in order to measure its intrinsic value at a specific point of time. A fundamental trader will analyse macroeconomic factors and country-specific factors such as GDP, inflation, trade balance, employment data, and the central bank’s interest rate decisions.

By assessing the relative trends within these economic indicators and other data, traders are analysing the health of the country’s economy. Thus, one could say that by assessing the economic environment within a country, by extension you are assessing its currency. This assessment can then be compared to that of its peers on a relative basis, allowing traders to identify the opportunities where the value of a country’s currency varies from its current market price. Fundamental analysis outlooks tend to focus on the medium to long-term.

An example of fundamental analysis will be the fact that investors have recently been expressing their concerns (often referred to as market sentiment) that the Feds shrinking of its balance sheet, combined with aggressive interest rate hikes has significantly raised the risk that the Fed will overtighten monetary policy and thus cause a recession. 

Technical Analysis

Technical Analysis is used to forecast the potential value of a currency through evaluating the demand and supply data reflected by charts. It is based on the idea that the value of a currency moves in trends. These trends are based on the underlying attitude and psychology of the traders in a market (sentiment). Technical analysis outlooks tend to focus on short to medium-term.

A technical foreign currency trader will assess the price action, trends, chart patterns, support and resistance levels, which tend to repeat over time. Furthermore, traders will combine this with the use of indicators and oscillators, which allow for more accurate analysis of the supply and demand in foreign exchange markets. This provides important insights to support trading decisions such as price targets, or when to enter or exit a trade. These are usually referred to as significant market levels.

Examples of the most common indicators and oscillators in technical analysis tend to be, Moving averages, Bollinger Bands, Moving average convergence/divergence (MACD), the Relative Strength Index (RSI), and the Stochastic RSI.

Conclusion

Fundamental analysis and technical analysis are the two major schools of thought when it comes to how traders approach the markets. There is an age-old question about which type of analysis is better. However, the benefits of combining fundamental and technical analysis in one’s foreign exchange policy are wide ranging. Creating a foreign exchange policy which accounts for both techniques and is tailored to your business is ultimately the optimal choice. Current forex markets have been extremely volatile this year so it is almost non-existent that a company can execute the most optimal trade over a certain period. Thus, traders will aim to maximise a company’s return on a position at various points in time and smoothing their overall foreign exchange position to account for those volatile periods. Additionally, an effective risk management policy also needs to include establishing the correct position sizes, the setting of relevant stop-losses and take-profits, and determining a company’s risk appetite and time horizons, while simultaneously controlling one’s emotions when entering and exiting positions.

If you would like assistance in setting up a foreign exchange risk management policy, Contact Dale Petersen on 021 819 7802 or at dpetersen@wauko.com to connect with us.

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