A substantial amount of intraday and intraweek volatility reflects the swings in forex market sentiment. Traditionally, economists have either ignored such short term periods or suggested they could not be predicted.

While flow and forex technical analysis have done much to dispel such a view, recent work on the relationship between “risk appetite” and asset prices has made a real breakthrough in terms of being able to predict those short-term swings in sentiment and in turn how they affect currency and asset prices.

Risk appetite or market sentiment are not easily definable concepts given that what these are focusing on is the investor’s willingness or otherwise to invest—which is not always based on logic! Despite such difficulties, the private sector has over the past few years been hard at work creating “risk appetite indicators” to measure overall conditions for risk tolerance across currency and asset markets.

Within the forex trading investment banks, JP Morgan created its “LCPI Index” Bank of America has its “Global Hazard Indicator” and Salomon Smith Barney its “Instability Index”.

Some traders have the wrong perception that supply and demand are completely independent of one another. Let’s think about it for a moment.

If this was true, price trends could not exist at all, because forex markets would immediately work to remove any supply or demand imbalances. The fact that this doesn’t happen and that price trends do occur suggests that there are intervals, sometimes substantial intervals, before such imbalances can be reduced.

Besides, supply and demand are not completely objective concepts. They reflect the views stated by market traders, who make up that supply and demand. In other words, supply and demand are both cause and effect.

What does this mean in practice?

Currency traders know well that particular flows will have more effect than others and thus will materially affect the supply/demand dynamics.

Currency market possesses a certain dynamics that no other financial markets have. Unlike in the case of equity or fixed income markets, the mainstream of forex market traders is speculators in one way or another.

Global merchandise trade going through the forex market makes up around 1–2% of total volume. Allowing foreign direct investment, we increase the volume contribution to about 5%.

Asset market volumes have risen sharply over the past 20 years as barriers to capital have fallen. Having made up only a small proportion of currency market volume before the end of the Bretton Woods exchange rate system, they probably now make up as much as 35% of total currency market volume on a daily basis.

That being said, there is still 60% of daily currency market volume, which has to be assigned to “speculation”. Despite the fact that the figures presented here are very approximate, the idea of proportions is pretty clear.

As a beginner in forex you might wonder which market analysis is better, easier and most profitable – technical or fundamental. Is it better to focus on one of them, or rather syndicate the two for better results? What do other traders use to analyze price movements? 

Technical analysis uses forex market data, such as prices, volume, etc., together with technical indicators, such as relative strength index, moving averages, Fibonacci, etc., to choose the trading positions and estimate upcoming price movements.