Fundamental vs. Technical Analysis
In the Forex markets, deciding whether fundamental or technical analysis is the better approach is still a subject of debate. Ultimately, it comes down to your preferred trading strategy, which will largely be based on your analytical approach.
That said, most Forex strategies should seek to successfully combine aspects of both fundamental and technical analysis.
In this article, we take a closer look at the differences between the fundamental and technical analysis for online traders.
Understanding fundamental analysis
When it comes to valuing everything from corporate shares to real estate, fundamental research is a need in the financial world. Currency traders use it extensively to investigate the underlying causes of seemingly random variations in exchange rates.
A currency’s value is determined by its political, economic, and social elements, which are analysed using fundamental analysis. To make well-informed trading decisions in forex, it is necessary to understand what drives a currency’s fundamental worth.
Understanding economic factors that can influence currency supply and demand is all part of fundamental research in the Forex market.
To put it another way, the trader assumes that the value of a currency will grow if demand rises or supply falls. The price of a currency should decline if there is a decrease in demand or an increase in supply.
Fundamental analysis strategies
News trading
Using basic Forex trading strategies such as trading the news is one of the most common practices nowadays.
Trades are opened based on the release of economic data, either before or after, depending on whether the trader has a predetermined bias.
Statistics that are most significant to Central Banks (currency custodians) tend to have a big impact on the Forex market.
The GDP (Gross Domestic Product), the PCE (Personal Consumption Expenditures) and the CPI (Consumer Price Index), as well as the unemployment rate and the number of jobs generated, are usually the stats that cause the most fluctuation.
If the forecast for a country’s currency is favourable or bad, news traders can take advantage of heightened price volatility by influencing demand for a specific currency.
Carry trading
Keep in mind that you do not trade individual currencies on the currency market, but rather currency pairs. At the same time, you’re acquiring one currency and releasing another.
Holding a currency pair position for more than one day will result in overnight fees, which can be paid or received depending on the direction of your two holdings (long or short).
For the currency carry trade to work, there must be a difference in the funding rates for each of the two currencies involved. If you borrow money at a low interest rate, you can use it to buy a higher-interest-rate currency and make money from the difference.
Carry traders have long relied on the Yen and the Australian Dollar, both of which have extremely low interest rates, as a favoured currency pair.
Because of the low overnight swap rates available to retail traders, it is more difficult to execute a carry transaction.
If the forecast for a country’s currency is favourable or bad, news traders can take advantage of heightened price volatility by influencing demand for a specific currency.
Advantages of fundamental analysis
Allows traders to understand price movements
Market prices can be immediately influenced by major economic news and publications. When the numbers for an economic release are unexpected or dramatically depart from the consensus numbers, this is especially true, and can be understood with fundamental analysis.
Allows traders to pinpoint valuations
A monetary value can be assigned to any financial instrument or asset. A trader’s task is to look for assets where the genuine value of an asset is being undervalued by the present market price.
When it comes to analysing currency movements, currency analysts can use fundamental analysis to look at aspects such as interest rates, inflation, consumer sentiment, industrial output, and more.
Allows traders to analyse long-term trends
With fundamental research, traders may get a handle on the long-term trend of a currency or asset. The vast majority of the information contained in economic reports is evaluated on a relative basis.
Consider, for example, how today’s unemployment rates compare to those from the previous month, quarter, and year.
This will help us understand the present trend in unemployment, and we can then use that information, along with other economic statistics, to anticipate the long-term influence on the price of a currency pair.
Understanding technical analysis
Based on the examination of previous price movements, technical analysis is a forecasting tool. Technical analysis is sometimes referred to as an art rather than a science.
Trying to predict future price movements with technical analysis has numerous complexities, which might lead to conflicting findings.
Price data is the primary tool for technical analysis. An analyst can use technical analysis to make informed decisions in the markets by monitoring current price action and using that to compare it with past price movements in the market.
Markets such as stock indices, currencies and commodities as well as individual companies can be studied using technical analysis. Technical analysis can be useful as long as a market has sufficient liquidity and is not easily influenced by outside forces.
In the opinion of technical analysts, the present market price reflects all known facts. The price of a security is swiftly affected by any new information that is made public.
The technical analyst believes that the market has a predictable and non-random tendency that can be noticed by the trained eye. There is a tendency for a trend to arise from trading range activity, and then the trend matures before returning to a consolidation stage.
The pricing data on the markets exhibits a repeating and recursive nature. While there are no two price patterns that are exactly alike, there are some similarities that cannot be explained away by randomness or noise.
Chart formations, candlestick patterns, momentum footprints, volume, and other price-related data show these patterns, and therefore are included in the toolkit of the technical analyst.
Support and resistance strategies using technical analysis
Using trendlines and other technical indicators, it is possible to identify places where an asset’s price trend is about to reverse.
If the price is in an upward trend, a trendline connecting substantial higher lows is called an ascending support trend line. If the price is in a downtrend, trendlines connect major lower highs – a falling resistance trend line.
As such, the trend of a financial asset can only be predicted by the levels of support and resistance that it faces.
The levels at which prices could reverse to begin a new trend or a new movement within the primary trend are likewise represented by these levels of prices.
These zones show areas where bulls and bears have fought for control of the market in the past, indicating a “battle.”
It’s vital to keep in mind that in technical analysis there is an assumption that the past tends to repeat itself, thus market psychology plays a role here as well.
Support levels are typically where the bulls take control of the bears, preventing prices from falling further. A resistance level, on the other hand, is a point at which the bears seize control and attempt to halt the price rise.
Advantages of technical analysis
It can be applied over multiple timeframes
Whatever your trading style is (short-term, intermediate-term, or long-term), you can benefit from using technical analysis tools in your decision-making process.
It is great for understanding trends
In order to determine the current trend of the market, a technical analyst can employ a variety of various techniques and studies. The most common of these include moving averages, trend lines, channels, swing highs and lows, as well as support and resistance levels, among many others.
It can allow you to hone your market timing
The major responsibility of a trader is to identify the best trading opportunities that are accessible and then to execute the deal at the appropriate time.
Technical analysis tools assist traders in initiating, managing, and exiting their positions in a scientific and efficient manner, using a variety of indicators.
It allows you to develop algorithms
Algorithmic trading methods can be created using many of the concepts found in technical analysis. Automated trading systems can help alleviate some of the stress and anxiety associated with trading.
Once you’ve set up your trading system’s rules, you can step back and let the algorithm do the work for you.
It can allow you to get a ‘read’ on the market
A greater understanding of market mood extremes can be gained by analysing price movement and chart analysis. You’ll be able to identify extremes in investor sentiment during both run-ups and selloffs.
Moreover, you’ll get a better sense of where future demand and supply will be, allowing you to take advantage of market opportunities before your competitors do.
Final Thoughts
When it comes to market analysis, there are two main approaches: fundamental and technical. Most traders, though, will fall into one of two categories, which aren’t mutually exclusive.
Fundamental and technical analysis each have their own perks and disadvantages when it comes to analysis. Both tactics can work for you, and deciding which one is best comes down to your own personal trading style and goals.