When it comes to Forex trading, the million dollar question occupying all traders across the globe is how to best predict future movements of the market. Now, before we proceed, it is very important and crucial to emphasize the point that there really is no one way that can predict what will happen in the market with 100% certainty and accuracy. Having said that, there are various ways to analyze the Forex market and draw conclusions about the different currencies, both in the short and long term periods.
The two primary methods are what are known as technical and fundamental analysis. Just as there is no one method to predict what will transpire in the market, so too there is no absolute answer to the question which is better, technical or fundamental analysis. Many experts, who base their trading on technical analysis of the market, might tell you it is the ultimate method, and vice versa. So how do you determine what is right for you?
Before we discuss the ins and outs of the technical and fundamental schools of thought, it is important to understand one point. The best option is obviously to try and incorporate both types of analysis in your day to day trading. If you could take the best of both worlds and implement the principles properly, you are going to see the best results. However, most traders cannot focus equally on technical and fundamental analysis, so they do need to eventually choose which will be their primary method of market analysis.
“Forex fundamental analysis is a method of forecasting the future price movements of a financial instrument based on economic, political, environmental, and other relevant factors, as well as statistics that will affect the basic supply and demand of whatever underlies the financial instrument.”
Fundamental analysis is a more traditional tool than its competition, it has always been around, it was just referred to differently. Fundamental analysis means exactly as it sounds. You draw your market conclusions based on the fundamental principles driving the currencies. This can include the political developments of the country at hand. It will almost always include the economic happenings, and might even include environmental factors.
Fundamental analysis is based on the premise that where one currency or another will go is not random, and if we know the “action”, we are sure to be able to predict the “reaction”. Fundamental analysts will therefore trade with their eyes glued to the news, and will pay much less attention to what their currency did in the past. They will identify and quantify factors that determine the intrinsic value of a currency based on its supply and demand. If the supply is on the decrease and the demand increasing or staying the same, the value of the currency will obviously rise, and vice versa.
To just give a more concrete example, a Forex fundamental analyst will study the level of supply and demand of a given country’s currency, as well as its export and import numbers, its government stability and popularity, as well as the countries economic indicators. Based on all those factors and more, the analyst will draw certain conclusions about the strength of that currency and whether it is a wise investment for the average trader.
This is obviously a very thorough way of analyzing the market and is sure to see accurate results. The big question is, can everyone be a professional fundamental analyst or does it require vast knowledge in numerous complex issues?
- Thorough and comprehensive
- Relatively simple to decipher the relevant information
- Endless information to analyze
- Difficulty in measuring the relationships among the variables, how much attention should be paid to the political arena, as opposed to the economic or environmental?
“Forex technical analysis is a method of predicting price movements and future market trends by studying charts of past market action, which take into account price of instruments, volume of trading, and, where applicable, open interest in the instruments.”
Technical analysis is a much more scientific and objective method of analyzing the market. Before we get into the details of technical analysis, we should say that the basic and most elementary principle upon which all technical analysis is based is the sentence “The trend is your friend”.
Technical analysts do not dispute that there are forces that drive the Forex market, they just add another factor that fundamental analysts do not hold by. Technical analysis is based on the concept that what was yesterday paints a clear picture of what will be tomorrow. Technical analysts will not have the news open while they trade, instead, they will pay close attention to the daily, weekly, and monthly charts. If there is a pattern to be found in the charts, technical analysts will find it.
Technical analysis has the advantage of focusing on one or two charts and analyzing them, whereas fundamental analysts have to consume and analyze tremendous amounts of complicated data, and there is no indication what types of information are more important than others.
When it comes to technical analysis, there are 3 underlying principles:
- Although many factors affect the market and its currencies, including politics and economics, when it comes to technical analysis, the driving forces are irrelevant. What is important are the movements of the currencies themselves and not the reasons behind them.
- As I stated above, technical analysts will claim that if you look long and hard enough at the charts, you will notice a trend, or a certain pattern. Follow that trend, and you will come out on top.
- Trends are based on human psychology of how people trade the market, and will therefore continue.
To simplify the concept of technical analysis, we will say that it involves the gathering of historical data (there is over 100 years of recorded data in the Forex market), inputting it into a computer, which then searches the data for a pattern, later displaying it in graphical format.
OK, so we have concluded that technical analysis is a more focused and defined method of analyzing the market, but that does not answer the question, is it a more accurate method?
- Enables you to focus on one topic or chart and not analyze tremendous amounts of complicated data.
- Clear definitions of what information is the most crucial.
- Most trading platforms have built in technical analysis tools.
- Technical analysis completely ignores the driving force behind the currencies.
- The information is sometimes presented in a highly technical (hence the name) fashion making it hard to comprehend.
There is no one answer to the questions we have posed, but in order to cover your tracks, it is recommended to trade the Forex market making use of both methods, which each, as we have seen, have their own advantages and disadvantages.