Should You go for a Technical or Fundamental Analysis

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Forex: Foundation or technics?

Which direction of Forex analysis is the most efficient?

The fans of technical analysis adopted the principle “the price takes account of everything” which they use to counteract any kind of criticism. Why should one study the influence of fundamental factors on the currency rate if they are already reflected in Forex quotes? Why try to understand the position of central banks if the market knows what they think? If everything was that easy, any technical analyst could earn millions with no problems. In fact, different people interpret information in a different way. What’s more, who could guarantee that the data reflected in currency rates is true? For example, the market is now sure that the federal funds rate will be lowered in July, but will the Fed soften monetary policy in reality?

In no way am I calling you to give up technical analysis in practice! No way! This direction of market research is extremely important for making final trading decisions, defining targets and stop orders, and building a skilful risk management system. However, I think that only a wise combination of fundamental and technical analysis is a way to succeed. Macroeconomics helps us understand the background against which the markets are operating. A typical example is the current situation at Forex.

Fundamentally, the growth of Euro against the USD is linked to the Fed’s wider opportunities to soften monetary policy than the ECB’s. The federal funds rate is 2.5%, the ECB deposit rate is negative (-0.4%). Under such conditions, a trader should look for bullish patterns in EUR/USD charts. As I’ve already written, one of the most efficient patterns is Expanding wedge. It is a combination of raising maximums (points 1, 3, 5) and falling minimums (points 2 and 4). There’s a severe fight between bulls and bears in the market, and a common trader should use coyote tactics: wait for the winner and side with him.

Expanding wedge in EUR/USD chart

The theory says that a retracement which takes place after point 5 was reached is accompanied with lower trade volumes. It shows bears’ weakness. A trader needs to be more cautious: corrections to the levels 23.6%, 38.2%, 50%, and 61.8% of the wave 4-5 and a subsequent retracement are a reason to open long positions. Another confirming signal is needed and it doesn’t keep us waiting: the pattern of candlestick analysis called “bullish absorption” formed at the 61.8 retracement. The main advice is to buy at the return to the previous levels (50% and 38.2% of the wave CD). A protective stop-order is placed at the fluctuation minimum.

Strategy of work under Expanding wedge pattern

Technically, nothing can prevent EUR/USD from continuing its northern march. Fundamentally, further dynamics of the main currency pair will depend on a dialogue between Donald Trump and Xi Jinping at G20 summit in Japan. The US dollar is very likely to recover for some time. As a result, there will be consolidation and the “Expanding wedge” pattern will transform into Rhomboid Bottom. The traders familiar with the latter may have an opportunity to enter medium- and long-term long positions at the breakout of diagonal resistance.

Rhomboid Bottom pattern in the EUR/USD chart

So, fundamental analysis shouldn’t be given up because of the “price takes account of everything” principle. There are many aspects, invisible to a technical analyst’s eye. Only a wise combination of macroeconomic research and chart studying will allow staying in the market for a long time.

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Price chart of EURUSD in real time mode

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Fundamental vs technical analysis

There are some topics that spark never-ending debate and sow discord among people. What to buy – iPhone or Android? Which football team to support – Manchester United or Liverpool? You might have noticed that there is no clear-cut answer to these questions. As the old saying goes: tastes differ. Every man to his taste: the one man’s meat is another man’s poison. OK, there are many variations of this saying, we’d better proceed to our actual topic. What we wanted to say is that traders have their own eternal debate about the best way to make profits in the financial markets.

Technical

Some traders consider themselves to be “technical traders”. They rely on the price movement patterns and technical tools in their analysis and don’t pay much heed to the economic news flow. The only thing that matters, according to them, is the price of the currency/financial asset. Other things are just distractors.

Fundamental

Another team of traders disagrees with these “technicians” and advocates the fundamental way of market analysis. These guys scrutinize macroeconomic releases, pay attention to the news to unravel the future direction of the market – they are the adherers of fundamental analysis.

The first group of people is generally made of swing traders and short-term day traders who take positions for a day, several hours, minutes, or even seconds. Another group of traders acts more strategically; they prefer holding positions for days, weeks, or even months. They are the people of the virile, very strong character.

Comparison of analysis types in the table

Both fundamental and technical analysis have their advantages and drawbacks, so it’s best to combine these 2 methods. This way you will get the fullest view of what is happening at the market. While trading on the intraday use technical analysis first to determine the state of the market, trade entry and exit levels. Then use fundamental analysis to adjust your strategy taking into account events of the economic calendar. In the longer-term trade firstly determine the trend with the help of fundamental analysis and then look for an entry and exit point using technical analysis tools.

You will learn more about fundamental and technical analysis from this course.

What is the difference between technical and fundamental analysis?

This article explains the difference between fundamental and technical analysis so you can pick a form of analysis that is best suited to your trading personality.

Fundamental analysis

Fundamental analysis can be used to evaluate a number of trading instruments, such as shares, indices, currencies and commodities. Some traders will want to weigh up economic factors such as a country’s GDP, unemployment levels, company profitability and the health of a sector before taking a decision to buy or sell. This is all fundamental data.

In shares trading for instance, fundamental analysis can be used to evaluate factors such as the company’s performance, news reports, conditions in the sector and more. Let’s take for example a trader who uses fundamental analysis as part of his trading strategy. He is trying to determine where shares for Airline XYZ could be headed in the coming days, weeks or months. To do this, he would have to take into account factors such as the cost of oil, tourism numbers and even political unrest that could potentially impact travel within the sectors in which the airline operates. This is because rising oil costs would make flying more expensive for airlines, while political instability would discourage tourism, ultimately impacting profitability and the company’s share price.

Technical analysis

People who just look at price charts are called technical analysts. They argue that everything you need to know about a particular asset, be it a share, forex pair or commodity, is already being reflected in the price. Technical analysts plan their trades and investments based on price trends, chart patterns such as head and shoulders, and more mathematical chart indicators such as moving averages.

For very short-term trading, it’s fair to say that most people lean towards using charts. One obvious reason for this is that many traders are looking for relatively small movements and, although we are probably now exposed to more newsflow than ever before, there just isn’t enough major news that breaks all day long to continuously affects the markets.

Choosing between technical and fundamental analysis

As a new trader, which path should you follow and what approach works best? The honest answer is both! It is possible to make money using either technical or fundamental analysis, but maybe there is a happy middle ground where a blended style could give the best outcome.

It certainly pays to be aware when major fundamental news is being released. At the very least, even the most committed chart traders should know when the various central banks around the world are due to announce interest rate or other policy decisions. This, coupled with the release of major data such as unemployment numbers, can really move the markets. Trading with a head-in-the-sand approach around these releases can be expensive, as market volatility often picks up.

If there is a major change to what everyone was expecting, for example if interest rates go up or unemployment is much higher than expected, it can mean that a few words make chart patterns take a very different direction. But traders can use charts following the announcement to see if sentiment really is changing, or whether the burst of volatility was something of a five-minute wonder.

If a trend on the chart resumes after some unexpected news, then the market clearly does not think the news was actually that important. The person with one eye on the charts could well have the advantage here over those who just watch the news and are convinced that the market should be reacting differently – often a dangerous approach.

Risk management

Risk management is another area where a combination of the technical and fundamental approach could work. Economic news may tell you that the market’s attitude towards a certain financial asset is changing but it does not necessarily tell you when your view on the market is wrong. Using traditional chart points such as support and trend, for example, the fundamentally-biased trader can manage the risk on his revised market view if that proves ultimately to be incorrect.

The blended approach can also help confirm trends. If, for example, the majority of people are expecting an interest rate rise, but it doesn’t come, then the currency of that particular country would normally slip back. If it continues to rise then it can be a sign that there are other factors at play here and the interest rate element is not that important. How the market reacts to fundamental news can still be used by the technical trader.

It is maybe not too surprising then that there is no definitive answer to this, and the argument between the fundamental and technical approach is destined to rage on.

As ever there is no silver bullet that will ensure we are right all the time. But there are plenty of different and profitable trading strategies out there – be they purely technical, fundamental or a mix of the two. It’s all about finding a methodology that fits with your own particular trading personality.

CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

CMC Markets does not endorse or offer opinion on the trading strategies used by the author. Their trading strategies do not guarantee any return and CMC Markets shall not be held responsible for any loss that you may incur, either directly or indirectly, arising from any investment based on any information contained herein.

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