According to leading Forex broker, FXDD, technical and fundamental analysis are the two primary forms of financial analysis in the Forex market. Both techniques have their place in Forex trading, notes FXDD, and deciding which method to use often depends on the preferences of the individual trader and the time horizon of their trading strategy.
There are many benefits and pitfalls to both technical and fundamental analysis, according to FXDD. FXDD notes that technical analysis examines price movements within currency pairs and uses the data to forecast future price movements. FXDD says that in technical analysis, for example, an analyst would give greater weight to chart patterns and data patterns. Conversely, fundamental analysis studies economic and geopolitical events that can impact price movements in currency pairs, FXDD says. Analysts that rely heavily on fundamental analysis pay more attention to macroeconomic factors such inflation data, import and exports and gross domestic product, among other things, according to FXDD. These price movements change over time, FXDD says, due to many factors, including a country’s economic expansion and monetary policy.
By looking at the above fundamental factors, FXDD notes that a fundamental analyst attempts to determine the fair value of a certain currency pair. Analyzing Forex markets this way is more intuitive to most people, according to FXDD, and makes it fairly easy to evaluate. FXDD notes that if you believe the price of the currency pair is below its intrinsic value, then it may be a good investment. With fundamental analysis, however, FXDD notes that there is less emphasis placed on timing. Therefore, according to FXDD, fundamental analysis takes a more long-term approach to analyzing currency pairs when compared to technical analysis.
According to FXDD, technical analysis differs completely from fundamental analysis. While fundamental analysis is typically used for a long-term time horizon, FXDD says that technical analysis can be used for a shorter time-frame of days or even minutes. FXDD notes that traders that rely strictly on technical trading believe that there is no reason to examine the fundamental economic factors that may impact the price of a certain currency pair. Instead, technical traders believe that all the information that they need to make a trading decision lies in the data in the charts.
There are many critics of technical analysis that often cite the “efficient market hypothesis,” says FXDD. This concept states that the current market price of a certain currency pair is always the correct price and any past trading information is already priced into the pair. Therefore, FXDD notes that these critics believe any analysis to find undervalued currency pairs is useless. FXDD believes that there is no correct answer to who is right or wrong. Arguments can be made in favor of both sides, and because of this, FXDD encourages all traders to do their research and develop their own trading style.
FXDD believes that both technical and fundamental approaches have their place in Forex trading. Each approach is dependent on the preference of the trader and the time horizon and risk parameters that each individual defines. FXDD notes that there is, however, empirical evidence showing that following technical analysis of long-term trends helps to uncover longer-term technical patterns and that fundamental factors also do impact shot-term price movements.
According to FXDD, these two styles can even be used together for time horizons between three months and one year. FXDD cautions that there are analysts that believe that using both technical and fundamental analysis can be counterproductive. Because of their stark differences, technical and fundamental analysis are often thought to be mutually exclusive. However, many traders use both together, even instinctively. For example, technical traders often look at major economic reports and indicators, such as central bank meetings, job numbers and inflation data to inform their general bullish or bearish opinion, and then employ technical analysis to find the best time to enter the market. FXDD also finds that fundamental traders often look to technical charts for major and minor levels of support by examining moving averages and retracement formations to determine the best time to step into the market. FXDD says that timing entry into a currency pair can greatly improve trading gains. Many times combining both fundamental and technical analysis can prove to be a beneficial scenario for initiating a trade.
According to FXDD, there is not a defined formula for optimally combining both fundamental and technical analysis in Forex trading. There are computer programs available that claim to be able to select the optimal combination of technical and fundamental factors that influence trading. FXDD cautions traders that these programs are based on past economic, technical and quantitative patterns that often have little relevance in predicting future price action. FXDD believes the Forex market is simply too dynamic for a one-size-fits-all approach to combining these strategies.