Any smart trader knows that in order to be successful they must
be able to analyze the market and predict price movement. This is
true whether you trade in stocks, bonds, commodities, currency,
or any other for of security.
currency prices,
Analysis can be done in two different ways: fundamental analysis
and technical analysis.
Technical analysis is the study of prices. The goal is to analyze
the history of price movement in an effort to predict future
prices.
Fundamental analysis is the study of a nation’s overall economic
health. I like to think of this as “Big Picture” analysis. The idea
is that the strength of a nation’s economy will affect the supply
and demand for its currency, which will in turn affect the price of
the currency.
For example, let’s assume that the US economy is in a major upswing.
Since the economy is strong, the value of the dollar will be expected
to rise and currency traders will invest heavily in the dollar. This
bullish behavior becomes a self-fulfilling prophecy and the dollar
rises in value.
That’s a pretty simple concept, but judging the health of a nation’s
economy is no easy task. There are many factors to consider, and two
traders may look at the same figures and interpret the data differently.
consumer price index,
Fundamental analysts look at various economic indicators for signs of
an economies strength. Some of the indicators they analyze are the
interest rate, unemployment rate, consumer price index, and gross
domestic product (GDP).
These reports are released regularly by various government agencies and
non-government entities. You should find the latest schedule of upcoming
releases and put them on your calendar. Keep an eye on them for a few
months and see what effect they have on currency prices.
One thing to keep in mind: it is not always the numbers contained in a
report that have the greatest impact, but rather the relation of the
numbers compared to what was forecasted.
analysis
In other words, a rise in interest rates may not have a significant
impact if forecasters were expecting it. But if they were expecting
interest rates to remain steady and there was an unexpected increase,
there may be a large impact on currency prices.
A major disadvantage of fundamental analysis is that it can be a little
too “big picture”. It is great for predicting overall economic growth
and price changes, but it doesn’t offer enough details to target specific
entry and exit points. This is where technical analysis comes in.
Fundamental Analysis vs Technical Analysis
When it comes to analyzing the forex market, there
are two basic schools of thought. One is called
fundamental analysis, which is the study of a
nation’s overall economy. Proponents of this
big-picture view believe that price trends can be
predicted by analyzing various economic indicators
which give an overall picture of an economy’s
health.
The other school of thought is called technical
analysis. The core belief behind technical analysis
is that prices tend to follow patterns, and that by
analyzing past price patterns one can predict what
the price will be in the future.
But which type is better?
Well, to be honest neither. You need to combine both
types of analysis to become a successful trader.
Limiting yourself to only one or the other is a recipe
for disaster.
Why? Because by using only one method you’re only
looking at half of the picture. Let me use an example
to make my point.
Let’s say you’re a strict technical analyst and you have
no use for fundamental analysis. “What do I need to look
at economic indicators for,” you say. “I have my price
charts and they shall never let me down!”
As you study your charts, you begin to see an opportunity
forming. You’ve got 3 or 4 indicators showing that a huge
breakout is about to occur. The US dollar is about to go
on a rampage and rush to get in early. So you make the
trade, sit back, put your feet, and wait for the price
to soar.
But then something funny happens. The price drops 50 pips!
What the heck happened??
In disgust, you walk away from your computer and flip on the
television just in time to see the financial report. It turns
out that the latest Unemployment numbers were just released
and the number is much higher than expected. At the same time,
one of the world’s largest corporations announced that their
earnings were well under forecasted amounts, and they predicted
sales would continue to be sluggish through the next quarter.
Those two variables through a major monkey wrench in the price
rally you predicted. If only you had mixed a little fundamental
analysis in with all of those price charts you were busy
studying you may have seen this one coming.
Of course, using fundamental analysis alone is not the solution.
The big-picture view of fundamental analysis is great at
identifying general trends in price movement, but it does
not give a detailed enough look to provide entry and exit
points. Sure you may know that the Swiss franc is due for
a price increase, but how much? When should you buy and then
when should you sell?
Only by incorporating both methods into your trading system
do you have a chance to be a successful trader.
It’s a fact that simple systems beat complicated ones, as they are more robust in the face of ever changing market conditions.
A complicated one simply has too many elements and they break.
Keep It Simple!