Trading the financial markets is always based on analysis. Be it security analysis, price analysis or economic analysis. These are all aspects of fundamental vs technical analysis. Many traders rely solely on one type or the other.
However, many more traders have turned their analysis to include both aspects in recent years. You can obviously decide which one suits you best. But at the end of this guide, we believe you will also come to the conclusion that applying both analyses makes sense.
Whether you are trading forex pairs like the EUR/USD or trading stocks, you must have a full understanding of the processes applied in making trade decisions. Both analyses are designed to break down the decision-making process into something empirical. So that you are not trading on a gut feeling. Which quite frankly is more like gambling.
Fundamental analysis consists of looking at the factors that may give an asset its price. Originally the terminology started in the stock market. And is used to describe the assessment of a company’s empirical factors such as revenue, net profits, sales, debt-to-asset ratio and so on.
In the world of forex fundamental analysis applies to factors impacting the economy of a country. These factors determine how much demand there is for a currency and how much faith investors, traders, and merchants have in it. The main thing we look at in fundamental analysis are:
Fundamental analysis takes all this data for one currency and compares them to the data for the other currency in the pair. For example, a country with a faster expanding GDP than the other country will most likely see a higher demand for its currency in comparison to the other currency.
The benefits of using fundamental vs technical analysis can be expressed as the following:
- Concentrates on the underlying long-term trend
- Allows you to avoid small swings which distract from the main trend
- The information you need is publicly available
Let’s have a look at some of the disadvantages:
- Fundamental analysis is based on the current scenario but is also forward looking
- Gauging the extent of the forward view of a currency pair can be tricky
- Lack of reliable economic information when trading exotic currencies
- Headline news is not easily available in your language when trading exotic currencies
- Not suitable for day traders, scalpers, or any very short-term strategy.
Technical analysis involves the use of examining the previous price action of a forex pair. The analysis is based on the assumption that as humans we tend to have repetitive behaviour. And that the repetitive behaviour is also present in forex prices and prices of securities. It also relies on the notion that prices already contain all available information.
So, the recognition of these patterns is what helps a technical analyst identify opportunities for entry and exit of a trade. Note, that technical analysis relies completely on price action and does not take into account any other factors.
Some examples of the main technical analysis indicators and tools are:
- Moving Averages
- Relative Strength Index (RSI)
- Fibonacci Retracement Lines
- Moving Average Convergence Divergence (MACD)
- Bollinger Bands
- Elliot Waves
- Candle Patterns – i.e., Hammer, Harami and Morning Doji Star
- Chart Shapes – i.e., Triangles, Flags, or Head and Shoulders
Often technical analysts will use more than one tool or indicator in conjunction. When all the technical tools and indicators align in the same direction a buy or sell signal is triggered. Interestingly these tools and indicators can be used over various time frames.
Let’s consider the main advantages of technical vs fundamental analysis:
- Can be applied to short-term trading such as intraday or scalping
- Uses software accessible to anyone with a computer
- Eliminates the need of understanding the economics behind the forex pair
- Tools and indicators can be used over all time frames for long-term trades
- Improved decision making for market timing
These are the main limitations to using technical analysis:
- A steep learning curve to fully integrate technical analysis
- Many tools and indicators are only correct 50% of the time
- The same indicators and tools can be interpreted differently by two people
- Technical analysis tools may give contradicting signals among each other
Trading forex can be an exciting and liberating activity. However, you are going to need a lot of patience and practice before you become a proficient trader. You can read more on how to trade forex in our article here.
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