Fundamental Analysis vs. Technical Analysis
There are endless forex trading strategies that investors can adopt to improve their chances of achieving currency trading success. However, often traders can become confused by the numerous techniques and do not know where to begin.
Regardless of which currency pair or financial instrument you choose to trade, you will without doubt be using one or two analytical techniques, whether they are fundamental analysis or technical analysis. There is no data to suggest that one form of analysis is better than the other; instead, this typically comes down to the personality traits of the trader and the analytical method they are most comfortable with.
Each of these methods has distinct differences and advantages and disadvantages, while both require patience and discipline in order to be effective. Let's take a look at some of the key differences:
Understanding Fundamental Analysis
Fundamental analysis looks at an economy's macroeconomic picture. Fundamental analysts study the forces that drive supply and demand of a currency, as well as the international macroeconomics of that currency.
There are five primary factors to take into account during fundamental analysis:
- The financial health of a country's economy
- The relationship between imports and exports, which has a direct impact on a nation's monetary supply
- Level of inflation
- Interest rates
- The development of that country's real Gross Domestic Product (GDP)
Interest rates, inflation and GDP are all relative factors, meaning that the same measurements are compared against another country to establish the strength or weakness of those currencies. This means that they cannot be analysed in isolation in order to determine any results, as their results alone cannot give us an indication of a country's economic wellbeing.
During fundamental analysis the trader takes into account all of the above factors, using daily forex news and global market news as a primary source. Fundamental analysis also takes into consideration factors such as politics, society and shifting social norms. In order to understand whether a country's currency is appreciating or depreciating in value the trader will balance all of these factors against one another, offering an in-depth understanding of a currency pair and giving the investor the opportunity to execute a trade based on a very thorough analysis.
Since forex trading involves trading one currency against another, the trader must study and compare the economic health of both countries to determine which one is stronger. In trying to establish cause and effect between price action and economic development, fundamental analysts search for subtle errors in the market that they can capitalise on.
Other helpful tools include:
- An economic calendar: This is central to your trading strategy as it enables you to keep track of upcoming events
- The US Non-Farm Payroll Report: The US economy is a huge part of forex trading as the major currency pairs all include the U.S. dollar. Any news that might influence its value is big news, including the NFP, a U.S. jobs report released on the first Friday of each month that is a big focus for fundamental traders
Understanding Technical Analysis
Technical analysts take a very different approach. They look at charts and graphs to analyse the price of a currency pair and to see how it has changed over time. Technicians examine the patterns that the currency movement has made – as presented on the chart – in an attempt to predict the future price movements of that currency.
Some of the most common features analysed by technical analysts include support & resistance levels, trend and momentum and price patterns. To perform their analysis they use technical indicators to study price movement and visualise historical data.
Some of the most popular technical indicators include:
- MACD (Moving Average Convergence Divergence)
- Slow Stochastic
- Relative Strength Index (RSI)
- Bollinger Bands
The MetaTrader 4 platform offers an array of indicators to choose from, giving traders access to in-depth chart information to help them ascertain potential chart movements. While it's helpful to understand the workings of each indicator, it's best to not overcomplicate your analysis, therefore you should familiarise yourself with a maximum of four indicators to simplify your trading strategy before making entry or exit points.
Most forex brokers provide a full spectrum of forex analytical tools to online traders, as well as educational guides and information on how to perform technical analysis. Admiral Markets offers a range of forex & CFD webinars, including a weekly Markets Analysis and Strategy masterclass, as well as a wealth of articles, tutorials and much more.
Comparing the Two Types of Analysis
While technical analysis is considered very flexible, fundamental analysis is relatively rigid in its approach as it analyses the specific financial data of a given economy, going through each economy individually. This means that it can be time-consuming and difficult to understand while the findings cannot be applied across other economies.
For example, the financial data for Switzerland has nothing to do with the financial data for the USA, meaning that the analysis that is performed on the Australian dollar will differ significantly from the analysis performed on the US dollar. As such, a fundamental analyst cannot apply their studies across all economies. Each currency pair must be studied individually in order to gain an in-depth understanding of a particular economy against another.
Despite the intricacies of fundamental analysis, every trader will benefit from using it to some extent. By understanding market dynamics and drivers of an economy, the fundamental trader possesses the confidence to withstand market volatility and maintain positions for longer. Also, the longer the timeframe of trading the more accurate this form of analysis becomes.
To contrast, technical analysis is universal across all financial markets. Once you have mastered the ropes you will be able to perform this type of analysis across all financial markets, whether you choose to trade currencies, stocks, cryptocurrencies, CFDs or any other financial instrument.
One of the biggest benefits of technical analysis is that it helps traders to predict the trend of the market. With the help of chart analysis, uptrend, downtrend or sideways market moves are easy to predict. This method also takes less time to learn and gives a quick result for traders who use 1 minute, 5 minutes, 30 minutes and 1 hour charts.
Another benefit is that it also allows you to implement specific trading strategies, including the placement of stop losses or take profit orders as well as exit and entry points. Timing plays an important role in online forex trading and with the help of technical analysis, traders can predict the right time to enter and exit a trade in the hope of enabling good returns.
Fundamental or Technical Analysis?
Technical and fundamental analysis are very different from one another. While a fundamental approach to analysis is ideal for ascertaining what should happen on the foreign exchange market over a long-term period, a technical approach is better for determining more immediate, short-term predictions and this technique is much quicker to perform. However, many lucrative trades are made immediately following an economic announcement, with market-savvy traders jumping right in to a trade while technicians are busy crunching numbers.
Although there is no 'right or wrong' with regards to your analytical approach it is essential to use technical analysis if you are performing short-term trading and swing trading. This is because the markets are moving so quickly that there is little time to accurately perform fundamental analysis. However, if you are FX trading on a more long-term basis it is recommended to focus more heavily on fundamental analysis, as you will have more time to analyse macro-economic factors.
That being said, a mixture of the two is ideal as you need to have at least a basic understanding of the fundamentals to get your technical analysis right. Even if you are primarily a fundamental analyst, it is advised not to completely disregard technical analysis. By combining the power of both approaches, you will be better equipped and in a much stronger position when trading the forex market.