In forex trading, fundamental analysis and technical analysis are the two main schools of thought used by traders to influence their trade decisions. While these two are not mutually exclusive, most traders often use one of the analysis types.
From a data standpoint, both technical and fundamental analysis offer unique advantages to forex traders. To use these analysis options to your benefit, you need to understand what they are and how they differ. Here is everything you need to know about fundamental analysis and technical analysis in forex.
Technical analysis in forex trading
This is a data reading method that helps traders to forecast changes in currency prices in the future based on past price movements. Technical analysis can be affected by numerous external factors, sometimes leading to different outcomes.
Price data is the primary tool used in technical analysis and is the most important consideration. With this data, technical analysis can provide a framework for analysts to make market decisions by reading the current price action while comparing it with historic appearances.
Technical analysis can be used in different markets, including currencies, stock indices, individual stocks, futures, and commodities. As long as a market has high liquidity and is hardly influenced by outside forces, technical analysis can be the best way to make trade decisions in such a market.
The fundamentals of technical analysis are based on three core beliefs:
- Price discounts every other market aspect – technical analysis dictates that the current price of a currency pair is a reflection of all information available to market players. It also believes that any new data can quickly reflect in the security’s price.
- Price moves in an observable trend – technical analysis believes that price moves in a predictable trend that is non-random and thus observable by a trained eye. The trend starts from a trading range and moves into the consolidation phase before the emergence of a new trend phase.
- History repeats itself – technical analysis believes that market trends are repetitive and recursive even though there are no two identical price patterns in history. However, there are similarities in trend patterns that go beyond randomness.
Benefits of technical analysis in forex
- It can be applied to any trading timeframe, making it ideal for short-term and long-term traders.
- Ability to analyze different trends using different studies like trend lines, moving averages, support and resistance, swing highs, and lows, among other studies.
- Helps with timing trades for the best trading opportunities.
- Technical analysis shows the mood of the market.
- It is simpler to use and less time-intensive.
Fundamental analysis in forex trading
This is a type of forex market analysis that determines the underlying value of a security by assessing and studying economic data. In forex, fundamental analysis evaluates the overall conditions of an economy using different data such as employment rate, GDP, interest rates, and inflation, among other factors.
In the forex market, fundamental analysts are mostly interested in central bank activity. This means accessing stakeholders’ meetings, interest rates decisions, and speeches made by high-ranking central bank officials.
Fundamental analysts gauge the overall market conditions by use of different economic reports where they seek to find mispricing that can offer good forex trading chances. Most fundamental traders are short-term traders interested in capturing price moves in volatile periods. They can also be long-term traders interested in monthly or annual trends.
Fundamental analysts are more focused on the why as opposed to the what. They seek to understand the cause of different economic standpoints and use this data to forecast the market. Most fundamental traders use the forex market to buy high yield currencies against lower yield ones. Referred to as carry trade, this strategy is common amongst most long-term fundamental traders as well as global investment funds.
Benefits of fundamental analysis
- It helps to explain price movements through studying major economic news and other factors that drive up currency prices.
- Fundamental analysis provides the trader with insight into global markets. This gives the trader a better understanding of a country’s economy and other economies globally.
- Fundamental analysis makes it easier for an analyst to find currency valuation by studying consumer sentiments, inflation, interest rates, and industrial production, among other relevant factors.
- It provides long-term trend patterns.
Which one is best?
The best analysis type for you depends on the kind of trader you are and the kind of data you are after. Some traders prefer to use one of the two, while others use a blend of both. When it comes to choosing, there is no right or wrong answer. You only need to take time to understand both approaches and find the one that works best for your forex trading techniques.