Lesson Five: Fundamental vs. Technical Analysis
There are two key areas of research or analysis which can provide insights to develop trading strategies. Most forex traders focus on technical analysis perhaps because it appears easier to start with and because it involves patterns in statistics, you may be aware of the old age: “history repeats itself.” If we can find patterns on a chart and we know what happened in the past we can make some predictions about what will happen next.
However, anyone who has reviewed an economic calendar understands the importance of fundamental analysis. Fundamentals are basically big economic data that central banks and market participants follow to understand the current economic state, as an example, GDP or economic growth. Similar to technical analysis, we search for trends or patterns which repeat themselves to understand whether things are moving a positive or negative direction.
A novice trader will use either technical or fundamental analysis; however a well-informed trader will use a combination of both. We tend to use fundamental analysis to identify which currency pairs we should be focusing on and we use technical analysis to understand when we should enter or exit our trades.
There is one more layer of analysis which is vitally important in the market and that is sentiment analysis. Sentiment analysis allows us to understand how the market is reacting to different information that is feeding through news channels or in the form of data releases. Oftentimes, the reaction to data can differ from what the actual result indicates. This is especially true during times when central bankers such as Mario Draghi present at events like the ECB Press Conference. A word or a stutter can cause great reactions from the market despite underlying fundamentals remaining the same.
The key takeaway is, if you are beginning your trading journey- you must always be aware of any major events taking place during the time you are trading. We want to avoid being unexpectedly and often, quickly moved out of our original trading position because major news was released and we were unaware of it- or had not planned for it.