In this approach the analyst would look at economic, social and political forces that drive supply and demand. Those using fundamental analysis would look at growth rate, interest rates, inflation and unemployment.
This requires a lot of work and thorough analysis as there is no single set of beliefs that guides fundamental analysis. An analyst would need to continually be aware of news and announcements as this could affect the trading environment.
Currency movements are a result of supply and demand. A currency rallies because there is demand for it and currency values decrease because of excess supply. There are many factors that contribute to the net supply and demand for a currency and it is not as simple as one would think.
The above diagram shows the US Dollar/ Canadian dollar currency pair before and after the 2016 USA presidential election. Prior to the election the currency was drifting down and the dollar was showing weakness. After the election there was major US dollar strength in comparison to the Canadian dollar. A fundamental trader would not be able to predict the winner of the elections so it would have been difficult to put in a buy order. In this particular instance I had a sell order on this pair because it was drifting down and I was stopped out on the trade because the price reversed so strongly.
This approach focuses on the study of price movements. Historical currency data is used to forecast the direction of future prices. The underlying belief is that all current market information is already reflected in the price of that currency. Technical analysts also believe that history repeats itself and that the market psychology never changes.
The primary tool in technical analysis is price and charts. Traders will look for trends and patterns to find trading ideas. The big profits lie in the ability to capture and participate in big market moves. This is known as trading with the trend and it is a skill that can generate huge profits for traders. Range bound trading is also a viable strategy and basically captures profits when prices moves between a low and high price range.
The image above is an example of a strong uptrend. Notice how the price moves up and down but with the dominating direction being up. The price is constantly moving in this wave like motion which can provide interesting details about what is happening in the market. For example the area circled in yellow shows that the price momentum is starting to slow down and starting to flatten. This is a first indication that the trend might be slowing down.
Fundamental analysis or technical analysis?
There are strong supporters for both of these approaches. However rather than expending energy trying to prove that one is better, a trader should use the BEST of both these approaches. Fundamental analysis can be a great warning for increased volatility in the market. Major events like the US presidential elections or Unemployment data in the USA can cause volatility in the market. It is unwise to trade in such volatile markets so a trader should not place any trades till after the major news. There are some situations that can’t be explained by the fundamentals, just sudden shifts in sentiment that will only be picked up by studying the charts and price action. A trader must spend part of their analysis looking at major news events and then a portion of time studying the chart patterns before committing to a trade.
This article provided a basic understanding of fundamental and technical analysis. A trader needs an understanding of both to be successful in the market. Understanding of the fundamentals can assist in avoiding volatile trading conditions and technical analysis will assist in market timing and taking advantage of recurring psychological patterns.
Forex fundamental and technical analysis