|Fundamental Analysis vs. Technical Analysis|
|Sunday, 10 April 2011 14:10|
by John Tardogno
Fundamental analysis and technical analysis are the two most widely used methods for making trade decisions in the Forex market. Fundamental analysis shows traders the “fundamental” characteristics of a currency and a reason for it's direction. Analyzing fundamentals such as interest rates, trade balance and monetary policy gives a trader an idea on how to forecast future price moves and make profitable trades.
Technical analysis shows traders the past price action of a currency. By analyzing significant price changes of a currency, a trader is better able to find entry and exit points. There is no holy grain both types of analysis have their advantages and disadvantages – the key to profitable trading is in maximizing the positives, and minimizing the negatives, of each and using them to make high probability trades.
While most technical traders will tell you you can't trade fundamentals I find it's the only way to determine when to start looking for a reversal in a currency or pair and I have been in many discussions about how the charts show you everything you want or need to know however I'm currently long USD/JPY from 79.342 while most technical traders are still waiting for an entry. I would not have bought at that level if I were purely a technical trader.
George Soros known as "the Man Who Broke the Bank of England" made a $1 billion during the 1992 Black Wednesday UK currency crises. Soros correctly anticipated that the British government would have to devalue the pound sterling. I would argue he did not do this using technical analysis. However when using fundamentals to make trading decisions proper money management is not only required it can be critical.
Fundmental trading is not for everyone! However for the trader who feels the need to understand why a currency’s price has moved, fundamental analysis has several advantages. Fundamentals can often explain a price move by describing an established correlation. When that correlation starts to change you know a reversal or a correction is immenent.
While explanations are always present in fundamental analysis, it is not always so easy to understand them. And once fundamentals are determined the really difficult work begins. How should you use the information and how can the interpretation be used to forecast future prices?
The challenge with fundamental analysis often lies in how we interpret conflicting information. For example, the release of very strong U.S. GDP data could send the USDX much higher. On the other hand, strong GDP data could also suggest the worst of a global financial crisis is over, causing a more positive market outlook and investment in “riskier” currencies relative to the U.S. Dollar – sending the Euro and British Pound higher, and the U.S. Dollar lower!
So is strong U.S. GDP good for the Dollar, or bad for the Dollar? Fundamental analysis, as a predictive methodology, will usually answer with “it depends.”
So if fundamental analysis attempts to answer “why,” technical analysis seeks to answer “where.”For example when yen buyers were unsuccessful at driving the price of the USD/JPY below 79.73 so this information suggests that based on price action alone, a profitable trade could be buying the USD/JPY with a stop below 79.73 which I how I ended up looking to buy the USD/JPY. But my reasons for looking for buy and not a sell were fundamentals.
While all other major currencies had managed to take out some key levels in recent weeks against the buck, the Yen still had not taken out its key level which came in by 79.75 in Usd/Jpy, the record level from 1995.
Market participants are fixated on taking out key levels, and until that barrier was broken I expected the Yen well bid. However, once the level was finally taken out, timing for an intervention in my opinion would be more than perfect, and could spark a major reversal in the currency.
So while While academic types may debate which type of analysis is superior, a profitable Forex trader simply learns to apply the best aspects of fundamental analysis AND the best aspects of technical analysis to make high probability trades.
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