Technical and Fundamental Analysis in FX Compared

LEARNING HOW FUNDAMENTAL AND TECHNICAL ANALYSIS IN FX TRADING DIFFER

Many traders wonder which type of analysis is more suitable for them. Should they focus on fundamental analysis or technical analysis? In this article we will examine what distinguishes these two types of traders and what kinds of information forex traders usually consider.

Technical vs Fundamental Analysis comparison

	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 in forex involves evaluating the overall economic health of a country, which in turn affects the value of its currency. Unlike technical analysis, which focuses on price movements, fundamental traders rely on various economic indicators to assess the strength of a particular currency.

A fundamental forex trader examines factors such as inflation rate, trade balance, gross domestic product (GDP), job growth, and the benchmark interest rate set by the country's central bank. These data points provide insights into the economic performance and stability of the country, which can influence the value of its currency in the forex market.

To stay informed about the latest economic data releases, fundamental traders often refer to an economic calendar. This calendar displays numerous data releases scheduled for each day. Traders need to know how to filter the calendar to show only the relevant information that pertains to the currencies they are analyzing. By keeping track of these data releases, fundamental traders can make more informed decisions about trading positions based on the impact the data may have on currency strength.

When evaluating economic data points, such as inflation, GDP, and job growth, a trader is essentially examining the overall condition of a country's economy and determining whether it is favorable to trade the currency of that country in the future.

By analyzing the trends and patterns of these data points in relation to each other, traders can assess the relative health of the country's economy. This analysis helps them make informed decisions regarding the potential movements of the country's currency in the forex market.

The following table provides a general summary of how different economic data typically impacts the strength of a currency. However, it's important to note that currency movements are influenced by numerous factors, and these effects are not guaranteed or set in stone. Other elements can also contribute to currency fluctuations in the market.

How economic data affect currencies

	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)	Negative
Central Bank benchmark rate	Increase in interest rate	Positive
ISM Manufacturing Index	Better than expected	Positive
PPI Producer Price Index	Better than expected	Positive

*In developed countries, a moderate increase in inflation is generally seen as a positive indicator of economic growth. On the other hand, developing nations perceive a decrease or stable inflation rate as a favorable measure since it helps control the rise in prices.

TECHNICAL ANALYSIS

Technical analysis involves the identification of specific patterns on price charts. Traders utilizing technical analysis focus on recognizing patterns such as triangles, flags, and double bottoms. By analyzing these patterns, traders can determine optimal entry and exit points. Unlike fundamental traders, technical traders are less concerned with the underlying reasons behind price movements, as their primary signals are derived from trends and patterns observed on the charts.

For instance, let's consider the double bottom pattern as an example. In this pattern, the market initially forms a low, experiences a slight rebound, creates a new low, and subsequently gains upward momentum as the trend reverses. Technical traders typically set a stop loss at the recent lowest low and patiently wait for the market to generate higher highs and higher lows before entering a long trade.

In practical application, technical traders would need to recognize the specific pattern illustrated below on the daily chart of the USD/JPY currency pair, where they can observe the formation of a distinct "W" shape.

A forex trader who specializes in technical analysis examines the movement of prices, trends, and levels of support and resistance on a chart. Many of the patterns used in analyzing forex markets can also be applied to other markets.

In addition, traders utilize various indicators and oscillators that are applied to a price chart for analyzing foreign exchange markets. Examples of commonly used tools in the technical trader's toolkit include moving averages, Bollinger Bands, MACD, Relative Strength Index (RSI), and stochastic indicators. These indicators are popular among technical traders because they are user-friendly and offer distinct signals.

The advantages of utilizing technical analysis

Technical analysis is not synonymous with 'mystical practices' as claimed by some proponents of fundamental analysis. Beginning to engage in technical analysis can be accomplished swiftly by evaluating the direction and intensity of market trends. Traders employ trend analysis to aid in selecting the most suitable currency pair to trade and determining the direction in which to trade.

Here's an illustration of how a technical trader might observe a significant 6,000 pip trend indicating the Australian Dollar (AUD) exhibiting considerable strength relative to the Euro (EUR) which is notably weak (hence the downward movement of the currency pair). Moreover, it is evident that the currency pair is following a distinct downward trajectory. Such a trend is commonly known as a 'trend,' and traders employ key levels, support and resistance levels, as well as indicators to swiftly and accurately identify such trends.

Gaining the knowledge of identifying robust and feeble currencies equips traders with insights into which currency pairs are more likely to exhibit trends, thereby increasing the likelihood of successful trades. By recognizing such trends, traders can engage in trades that align with the prevailing direction. In this specific case, a trader would execute a trade by selling the EUR/AUD pair to capitalize on the ongoing downward trend.

TECHNICAL AND FUNDAMENTAL ANALYSIS IN FX: SUMMARY

Fundamental and technical analysis have very different methods and perspectives for trading; providing unique value and insights to help trading decisions, and when to enter or exit a trade. While some traders like to use these types of analysis separately based on their preferred trading style and goals, many use a mix of the two. The advantages of combining fundamental and technical analysis are varied.

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