How to Use Both Fundamental and Technical Analysis in Foreign Exchange Trading?
Which kind of analysis is preferable for a trader is a topic of intense discussion. Which kind of trader is preferable, fundamental or technical? This essay will examine the distinctions between these two categories of traders and the sorts of data that forex traders, in particular, like.
Comparison between technical and fundamental analyses
| TECHNICAL ANALYSIS | FUNDAMENTAL ANALYSIS | |
|---|---|---|
| Definition | Forecast price movements using chart patterns | Various economic data used to establish value/ target price |
| Data considered | Price action (charts) | Inflation, GDP, interest rates etc |
| Time horizon | Short, medium and long term | Medium and long term |
| Skillset required | Chart analysis | Economics & statistical analysis |
FUNDAMENTAL ANALYSIS
Fundamental analysis entails evaluating a nation’s economy and its currency. It does not account for changes in currency rates. Fundamental forex traders will instead utilize data points to assess a currency’s strength.
The inflation rate, trade balance, gross domestic product, employment growth, and even the benchmark interest rate of the central bank are all factors that a fundamental forex trader would examine.
The economic calendar below shows how fundamental traders might stay informed about the most recent data releases. Because there are several data releases every day, traders should be able to filter the calendar to display just relevant information.
A trader determines the relative health of the nation’s economy and whether to trade the future movement of that nation’s currency by evaluating the relative trend of this and other data points.
The broad impacts that various economic statistics often have on a currency’s strength are summarised in the table below. However, this is not a certainty since various variables may affect how currencies move.
How economic data impacts currencies?
*Moderate inflation is welcomed in developed countries since it indicates a booming economy. Since it controls prices, developing countries consider declining or stable inflation a good statistic.
| EXPECTATIONS | EFFECT ON CURRENCY | |
|---|---|---|
| Gross Domestic Product (GDP) | Better than expected | Positive |
| Consumer Price Inflation (CPI) | Better than expected | Positive |
| Trade Balance | Trade deficit (imports > exports) | Positive |
| Central Bank benchmark rate | Increase in interest rate | Positive |
| ISM Manufacturing Index | Better than expected | Positive |
| PPI Producer Price Index | Better than expected | Positive |
TECHNICAL ANALYSIS
Recognizing patterns on a price chart is a key component of technical analysis. Technical analysts search for price patterns like flags, triangles, and double bottoms. A trader will choose the entry and exit locations based on the pattern. Because the trends and patterns on the charts serve as their signals, technical traders are less concerned with why something is happening than fundamental traders are.
The double bottom pattern is an example of a chart pattern below. The market makes the first bottom, recovers a little before making a second low, and then picks up speed when the trend changes. Technical traders will wait for the market to generate higher highs and higher lows before executing the long trade and will attempt to establish a stop loss at the most recent (lowest) low.
Technical traders must learn to recognize the pattern, which is seen below on the USD/JPY daily chart and has a “W” form.
The price movement, trend, support, and resistance levels shown on a chart will all be evaluated by a technical forex trader. Numerous patterns utilized in the technical analysis of the forex markets are also applicable to other markets.
When examining the foreign currency markets, traders also utilize oscillators and indicators added to a price chart. A technical trader’s toolbox usually includes moving averages, Bollinger Bands, MACD, Relative Strength Index (RSI), and stochastic. Technical traders choose indicators because they are simple and provide distinct indications.
The Advantages of Technical Analysis
The “black magic” that many fundamentalists assert is not a part of technical analysis. One may swiftly begin the technical analysis by evaluating the direction and force of trends. Traders will use the trend analysis to choose which pair to trade and in which direction.
Here’s an illustration of how a technical trader may identify this 6,000-pip trend, in which the AUD is mighty compared to a weak EUR (which is why the currency pair is moving down). In addition, it is easy to observe that the currency pair is moving firmly downward. This is known as a trend, and traders utilize key levels, support and resistance, and indicators to accurately and quickly identify trends.
Knowing which currencies are strong and weak can help traders determine which currency pairings are more likely to trend, resulting in trades with greater probability. Selling the EUR/AUD pair would be a trade in the direction of this specific trend.
CONCLUSION OF THE TECHNICAL VS. FUNDAMENTAL ANALYSIS IN FOREX
While giving distinct value and insights to help trading choices, the fundamental and technical analysis includes different tactics and approaches to trading. It guides on when to start or leave a trade. Depending on their desired trading style and objectives, some traders employ these sorts of analyses separately, whereas many do the opposite. Combining fundamental and technical analysis has several advantages.
ADDITIONAL READING TO DETERMINE WHICH TYPE OF ANALYSIS IS BEST FOR YOU
- Many fundamental traders keep an eye on the publication of economic data to trade the news. Since volatility might increase after significant releases, traders must use solid risk management strategies.
- Technical traders use different types and methods. By adequately exploring them, this kind of analysis fits your personality.