Fundamental Analysis versus Technical Analysis

Jan 10, 2010
Robin Lofton

Currency traders are faced with a number of decisions when entering the Forex market. One of the most difficult—and most important—decisions involves research. Of course, there are hundreds of different currencies and currency pairs to consider. But the most important research decision faced by traders is whether to use fundamental or technical analysis. This question has plagued currency traders (and stock traders) for many years.

Unless the trader is using an automated trading system, research will be one of the most critical steps for currency traders. Research involves many different decisions, but the decision of whether to use fundamental analysis or technical indicators is undoubtedly the most difficult and significant decision for traders.

Fundamental Analysis

Fundamental analysis is the study of the economic, social, and political forces that affect the demand for a currency. Many traders focus only on economic data as a fundamental factor affecting currency prices. These are the macroeconomic indicators, such interest rates, inflation, and unemployment. Indeed, economic reports are the biggest proportion of fundamental analysis.

Economic reports are released at regular intervals. However, economic reports are not always predictable. Economic reports can move the currencies market in big ways. But all economic reports do not affect the market in the same way. Some reports affect the markets around the world on a regular basis while others are hardly noticeable to currencies traders.

The three most important economic reports for the Forex market are: the Employment report, International Trade in Goods and Services report, and the Gross Domestic Product report.

Other fundamental factors include elections, political speeches, wars, natural disasters, terrorist attacks, or any socio-political event that increase or decrease the demand for a currency. In turn, these events affect the value and price of a currency.

Technical Analysis

Technical analysis is the study of price movement of a currency. These movements are shown in charts and other technical indicators like moving average lines, Bollinger Bands, Japanese candlesticks, or MACD lines.

Many people feel that reading charts and indicators is like learning a foreign language. There is some there is truth to this belief, because the trader must learn what the lines, bars, and ticks mean. However, once they are learned, the indicators can be quickly and easily interpreted.

Charts provide a wealth of information about the price movement of a currency pair. They can be used to predict how a currency pair will move, whether a currency pair is overbought or oversold, whether a currency pair is facing upward or downward pressure, the strength of a trend, and a lot of other information regularly needed and used by Forex traders.

There are hundreds of technical indicators available to traders. Each indicator provides a certain detail about the price movement of a currency pair. For this reason, it is very difficult to determine which technical indicators are most useful for every Forex trader. However, there are several indicators that many Forex traders use on a regular basis.

These would be Japanese Candlesticks, moving average lines, Bollinger Bands, and Average Directional Index (ADX) lines.

These indicators are considered basic tools for Forex traders. Charts with various time frames, Fibonacci retracements lines, MACD, and stochastics are also useful for currency traders.

Economic Reports versus Charts

So, which type of research is more useful to Forex traders? Some traders believe that the macroeconomic data provided by fundamental analysis is more important because it gives the general framework for finding strong trades and identifies long-term price pressures.

Other traders assert that technical analysis is more important because it shows the price patterns, trends, and price movements that help traders find good trades as well as know when to enter and exit them for maximum profit and risk management.

The real answer is that both types of research are important. They both help to identify good trades. They both can be used to identify price movements and direction.

However, technical analysis is more often used in Forex trading because the currency market often develops strong trends. There are many indicators that can help to locate trends, such as moving average lines and Japanese candlesticks. There are even indicators that show the strength of a trend such as ADX level. Fundamental analysis does not provide this information.

Still, fundamental analysis is very important in the Forex market because it identifies economic and political factors like the release of an important economic report or an interest rate change, which can trigger major price movements.

In short, most experienced traders will focus on technical analysis, but also keep a sharp eye on important fundamental factors.