In Forex trading, there are two main types of analysis – fundamental analysis and technical analysis. There is no answer to which technique is any better as it depends on a trader’s personality, but need patience and discipline on the part of the investor.
Each has distinct differences and advantages and disadvantages, and the differences between the two approaches dictate how traders approach their work.
What is Fundamental Analysis?
Fundamental analysis is the art of measuring value, studying the economics of a country and examines the underlying economic conditions of a currency. Following the macroeconomic environment can be an exhausting approach if you are not up-to-date on economic news. For traders who have a good knowledge of economic news, and understand macroeconomics, this could be a very profitable approach.
Generally speaking, traders buy currencies with stronger economies at a low price and sell currencies with underperforming economies. Then traders keep these currencies in the hope that prices will move back up to their fair market value. It can take years for undervaluing currencies to rebound and the exchange rate to rise.
As a fundamental trader, be smart about the trades that you choose. If you fail to do so and get caught in a sideways ranging market, you could go without getting paid for some time.
Fundamental traders can profit from significant news events. As a trader with knowledge of an upcoming event, you should research the potential outcome of the event, and buy into your position. The market will become volatile during this event, and the prices before and after will have changed.
Fundamental trading is also better for position traders who keep trades open for more extended periods. This form of trading is even better for those who can not spend time micromanaging trades which is more normal if you have a day job or other obligations that are often prioritised. So, fundamental trading is most appropriate for two types of traders. Either those up-to-date on significant news events and can research thoroughly, or position traders.
If you have time to spend in front of a computer and enjoy chart analysis, then technical analysis could be a better approach for you.
How to get started with Fundamental Analysis?
Fundamental analysis is mostly about being aware of upcoming news events, and reacting quickly to the unscheduled ones. Here is some additional reading to get you going.
- The Economic Calendar: This calendar is going to be central to your trading strategy. A fundamental trader will always know when big events are about to happen. There is no such thing as an unprepared fundamentals trader.
- The US Non-farm Payroll Report: The US economy is a big part of Forex trading. The major currency pairs all include the US Dollar (USD), so any news that might affect its value will be big news. This jobs report is released at 08:30 (New York, USA) on the first Friday of the month which is usually a big focus for fundamental traders.
- EURUSD Analysis – Know the history of the pairs you trade, as you will see the same seasonal trends and repeat performances.
Fundamental Analysis Example
Here is an example of how the release of positive NFP (non-farm payroll) reports can affect the market. Should a trader expect this report to show robust job creation, we open a trade before the report is released and go long.
Traders have options of how long to keep the trade open for, as this will affect profitability. When a set profit target is reached, a trade can close automatically using a take profit order, or a trader will continue to monitor the data and try to extend the gain, and close the trade manually.
While Fundamental analysis is not chart based, it is essential to understand how to read charts to confirm that the trade is going in the direction expected. In the case below, the chart shows that the trader would have made 100 pips of profit in 5 minutes, and should they have kept the trade open longer, they would have made 200 pips of profit. Having held the trade open a little longer would have been a more profitable trade.
What is Technical Analysis?
If fundamental traders focus on news events, technical traders concentrate on reading price charts. Technical traders use a variety of tools and indicators to help them identify trends and patterns, and helps traders to identify high probability situations. These are ones in which the currency pair has a good chance of moving in a specific direction.
Experienced traders know how to turn a high probability trade into short-term profits, regardless of whether the market is moving up or down. The ability to make money in any market is one of the most significant benefits CFD and Forex trading.
A common excuse people have for not learning how to do technical analysis is the notion that you need to spend all day in front of the computer to be successful. The advantage of technical trading is the ability to make good consistent gains in any market without feeling like you have a second job.
How to get started with Technical Analysis
Here is some further reading to get you going with the basics.
- Down Theory: Dow Theory is the basis of all technical analysis, and is a good introduction to basic concepts.
- Charts: This is the first part of a two-part series we have on charts. It will give you an introduction to chart types and how to compare periods. The second part is here when you are ready.
- Directional Bias: One of the principles in Down theory states that a market will continue moving in a direction until something happens to affect the momentum.
- Momentum: Markets change direction because of a decrease in momentum. A technical trader needs to know how to watch for changes here.
Technical Analysis Example
In this example, we are using the charts and a momentum indicator to time the exit of a trade. Because markets will maintain a trend until there is a change in momentum, we can watch for a shift in momentum to indicate that the market could reverse. Investors will close the trade when they see this change, as they know potential profits are maximized.
Technical Analysis vs. Fundamental Analysis
Both the technical analysis and fundamental analysis have their limitations which is the main reason why some professional traders choose to combine the two. If both technical and fundamental data suggest a profitable trade, the probabilities of success can increase considerably.
There is another school of thought that believes that all fundamental factors are already priced into the data, which means that you only have to read the technical data to predict the markets best. If you adhere to this school of thought than technical analysis is a superior form of trading for you.
Some question the validity of technical analysis. The efficient market hypothesis claims that all past price information is already reflected in the current price. If this is the case, since all the data in the charts is old information, there is no exploitable data to beat the markets. And in this way, fundamental trading is the only way to accurately speculate on future pricing.
Every successful trader knows that it takes study, practice, and dedication to get to the point where you can achieve consistent monthly profits. Whichever way you choose to trade, you have to trade with knowledge and discipline.
You don’t have to worry about which one of the two approaches is better. Instead, take advantage of both of them to help make better-informed trading decisions, and help you find more opportunities.