Forex technical analysis and Forex fundamental analysis complement each other for the perfect trade. While fundamental analysis gives the reason, technical analysis shows the direction of a trade.
So far, so good. But what makes technical and fundamental analysis?
The two notions are so vast, is impossible for one trader to master everything. Hence, retail Forex traders must adapt. And, learn what matters the most.
The best Forex analysis isn’t the one that incorporates technical analysis only. Nor, Forex fundamental analysis only.
It is a mix of the two. Plus, the time-horizon of a trade.
For example, investors keep positions open for an extended period. Ranging from a couple of months to years, time isn’t an issue. As such, any monthly economic report won’t affect the trading decision.
Swing traders and scalpers, on the other hand, check everything. Every level, every news.
And, for a good reason. They mostly use technical analysis theories and indicators in their trading.
With this article, we aim to travel into the world of both Forex technical analysis and fundamental analysis. Here’s what we’ll cover:
- What is technical analysis
- What is fundamental analysis
- History of technical analysis
- Technical analysis of various financial markets
- Forex fundamental analysis in the 21st century
- Macroeconomics as a Forex fundamental analysis driver
- How to compare economies
- Major economic data to consider
- Most crucial Forex technical analysis trading theories
- Japanese Forex technical analysis patterns
- Forex fundamental analysis Forex technical analysis
In the end, the difference between Forex fundamental analysis and Forex technical analysis should be noticeable. Moreover, traders will get the chance to pick what suits their trading style best.
So, let’s move on…
Technical Analysis in Forex Trading
Technical analysis refers to the ability to read a chart. And, to forecast future prices based on the interpretation.
Technical traders have a saying: “everything on the left side of the chart is free information.” It means that the price leaves traces we can interpret when trading.
With online trading expanding rapidly, any retail trader has access to a trading platform. And, any trading platform has a charting functionality.
From the moment a trader opens a chart, a whole new world of possibilities appears. Just let the imagination run!
Here’s how a naked chart looks like. Or, what traders see when they first open a chart.
It may not seem much, but early technicians didn’t have this luxury. They kept prices on paper and built charts by hand.
Nowadays we take technological advances for granted. Moreover, with so many technical analysis indicators, oscillators, trading theories, we tend to lose focus on what matters the most: forecasting prices.
Because Forex trading today depends on algorithmic trading, retail traders find it difficult to chart a currency pair. They either place the stop loss too tight. Or, the market just doesn’t move. So, they end of overtrading.
Forex technical analysis helps to have a disciplined approach. It provides the entry, stop loss and take profit for a trade.
What else can traders ask for?
History of Technical Analysis
Charting, as technical analysis is also known, appeared in the United States. Where else?
In no other place in the world where population embraced the stock market and capitalism so fast. And, with so much enthusiasm.
To this day, the United States of America is the place where financial world ticks. Or, where speculation began and continued.
By looking at market prices and recording them, traders spotted patterns. That is, the price of a stock or commodity keep doing the same thing under certain circumstances.
It wasn’t long before traders with technical abilities started documenting the patterns. And so, technical analysis was born.
Late 1800’s and middle 1900’s were prolific years. Almost everything traders use in a Forex analysis today comes from that period.
Here are some of the most representatives:
- Elliott Waves Theory – 1940’s
- Gann Theory – 1920’s
- Gartley – 1940’s
- Point and Figure – early 1900’s
- Dow Theory – late 1800’s
Those years are famous also for the birth of:
- Head and shoulders pattern
- Ascending and descending triangles
- Rising and falling wedges
- Double and triple tops and bottoms
- Bullish and bearish flags
- Cup and handle
- Rounding top and rounding bottom
Virtually all these patterns belong to the so-called Western technical analysis approach. For you see, no one knew that other approaches existed.
Charts evolved too. Traders favored bars charts over line charts for a single reason: they showed the price action within the bar.
Because a line chart connects merely the closing prices (or the opening ones, depending on the settings), they tend to lose valuable information.
The Birth of Technical Analysis Indicators
When the Personal Computer (PC) appeared, everything changed. Even before its invention, technical traders used mathematical formulas to plot simple technical analysis indicators.
Therefore, concepts like moving averages already existed. However, after 1960’s-1970’s, technical analysis indicators increased exponentially.
This was the time when the most famous ones appeared, like the RSI and the CCI. But also, MACD, and so on.
As technical analysis evolved, traders felt the need to split indicators into trending ones and oscillators. Therefore, the way to approach the market changed too.
However, markets changed too. Some, don’t exist anymore.
Instead, others appeared. For example, Forex trading.
The biggest market in the world, the foreign exchange has an impressive daily volume. Over five trillion dollars of exchanged currencies per day! Every day!
Because of that, the question arises: how good is a Forex technical analysis using 1970’s technical analysis?
Moreover, how to trust a Forex trading analysis using Elliott Waves rules from the 1940’s? After all, if the markets changed, the patterns changed. Right?
Because markets differ, technical analysis models vary too. Some things simply won’t work in all markets.
For example, gaps. The standard interpretation of a gap is that it’ll close soon. At least, that’s in Forex trading.
However, if you trade stocks, gaps are common. They appear almost every day at the opening.
Hence, a technical analysis concept like this won’t work.
Nowadays, traders tend to make complex Forex charts analysis. They take advantage of the Personal Computers (PC’s) power and use multiple indicators/theories at once.
But simple Forex charts technical analysis methods still work. Concepts like:
- Support and resistance, etc., haven’t lost their predicting power.
Therefore, Forex technical analysis should be a mix. Or, a blend of classic and modern technical analysis concepts.
Japanese Candlesticks Charts in Forex Technical Analysis
When everyone focused on the Western approach to technical analysis, something happened. The Japanese method reached the West.
For the first time, the West found out that Japanese used technical analysis concepts for more than three hundred years. Since 1700’s, the Japanese used candlesticks to chart rice futures.
Long story short, the Japanese candlesticks chart became the most popular in today’s Forex trading. And, Japanese candlesticks patterns too.
The most relevant are:
- The Doji candle
- Morning and evening stars
- Hammer and shooting star
- Piercing and dark-cloud cover
- Bullish and bearish engulfing
Their main advantage comes from the time to complete a pattern. It’s very short!
In some cases, one candle is enough for a convincing Forex technical analysis setup. It was a breakthrough compared with the classic patterns. And so, Forex technical analysis reached a new stage.
Forex Fundamental Analysis and What Matters in Forex Trading
Everything that’s not technical, it’s fundamental. And, with that, we’ve covered the main definition of fundamental analysis.
Before moving forward, we must make a distinction between different markets. In Forex trading, fundamental analysis mainly refers to economic news.
However, when trading other markets, like stocks, for example, thigs differ. Besides economic news, industry and company analyses influence prices too.
Besides economic news, a fundamental analysis Forex trader considers macroeconomics too. And, geopolitical events as well.
Economic News as a Major Fundamental Analysis Driver
Throughout the trading month, a plethora of economic news comes out. There’s an economic calendar well-known in advance that shows the upcoming news.
Moreover, the importance of it too. As such, interpreting economic news is part of any trading analysis.
The Forex dashboard is made of currencies paired together. Therefore, one way to trade a pair is to interpret the two economies. And, to compare them.
Typically, the stronger an economy, the stronger its currency. Hence, if the Forex fundamental analysis points to an expanding economy, traders buy that currency.
An objective fundamental analysis considers the same set of economic data. Here’s what matters for all major capitalistic economies.
Inflation or the Consumer Price Index (CPI) indicates a change in the price of goods and services. Why it matters, you say?
Because inflation is part of every major central bank’s mandate, traders react quickly to changes. When it falls, the currency depreciates too. And, when it rises, the currency appreciates.
The correlation between inflation and interest rates is not new. Since a few years now, modern economics tie inflation to economic growth.
Or, at least moderate inflation. What is that and why?
Two percent is a moderate target. Economic studies show that moderate inflation determines people to spend more often.
As such, the economic wheels keep spinning. Retailers will sell more stuff and order more from wholesalers.
However, wholesalers will have lower inventories. Hence, they’ll order more for factories to deliver.
Moreover, factories will employ more people. Or, will hike the wages to increase productivity.
More people employed translate in a lower unemployment rate. Finally, full employment reduces the unemployment benefits. You see: everyone’s happy with moderate inflation!
However, this is a basic Forex fundamental analysis. It aims to illustrate in simple words how the economic cycle works.
In reality, primary fundamental analysis drivers compete with economic news and move prices. Plus, let’s not forget that a couple means two. Or, two economies move a currency pair.
As such, it may be that the unemployment rate, for example, falls in the United States. Which, is positive news for the dollar.
However, it falls even harder in the Eurozone. Which, in turn, is positive for the Euro. What currency to buy?
Employment Data as Part of Fundamental Analysis
Forex fundamental analysis must consider employment data. Perhaps this wouldn’t be the case if it weren’t on the mandate of the most important central bank in the world: The Federal Reserve of the United States.
The Fed has a dual mandate. Besides inflation, it shifts monetary policy in such a way to create jobs.
No other major central bank has a dual mandate like this. Recently, the Reserve Bank of New Zealand (RBNZ) targets job creation too. And, for a good reason.
The thing is that the two (inflation and employment) go hand in hand. As such, why ignoring one and targeting only the other?
A full Forex fundamental analysis looks at the unemployment rate. Usually, an unemployment rate below five percent signals increased inflationary pressures.
Hence, traders will buy the currency even before inflation data comes out. Moreover, they’ll buy it even before the central bank moves on rates.
Across the world, all economies release the unemployment data. Hence, it is a mandatory indicator part of any Forex fundamental analysis.
The actual job numbers releases have different names, depending on the jurisdiction. From NFP in the United States to Claimant Count in the United Kingdom, they show the employment level in an economy. And, the labor market’s evolution.
Macroeconomics and Geopolitical Events in Fundamental Analysis
Besides the economic data listed above, the economic calendar is full of other releases. From first-tier data to third-tier, they help traders to form an opinion about an economy.
And, to act on it by buying and selling currency pairs.
However, that’s not it. Still, in the Forex fundamental analysis area, macroeconomic trends influence markets.
Or, macroeconomic news. Such news comes from areas like:
- Change in economic treaties between countries
- Budget deficit/excedent levels
- Tariffs introduction, etc.
Geopolitical and political events are fundamental news. Think of the Brexit referendum in the United Kingdom, the French and U.S. Presidential Elections in 2017, etc.
They all created volatility in the Forex market. In such conditions, no matter the Forex technical analysis setup, the fundamental analysis prevails.
Forex Fundamental Analysis vs. Forex Technical Analysis
Technical analysis as we know it changed. And, it’ll keep improving together with markets.
Markets change continuously. Comparing today’s Forex trading with 1970’s stock market trading is a mistake.
However, technical analysis concepts survived the test of time. Not all of them did, but the most precious ones. Or, the ones that adapted to the new reality.
The new reality means:
- faster execution
- robots taking almost all trades
- high-frequency trading
- tighter inter-market correlation
- new financial products (g., ETF’s – Exchange Traded Funds)
- new markets (e.g. cryptocurrencies), etc.
While Forex technical analysis concepts work in any market, Forex fundamental analysis doesn’t. Because Forex fundamental analysis is specific to the Forex market, it won’t work on different ones.
Another difference comes from the trading setup. A Forex technical analysis setup has an explicit entry, stop and take profit. Moreover, a risk-reward ratio too, part of a money management plan.
However, we can’t say the same for a trade derived from Forex fundamental analysis. Economic news may mean something; the central bank may do precisely what is supposed to do, and still the market to move the opposite way.
The best example comes from the recent Fed’s tightening. While it raised rates multiple times in the last couple of years, the USD fell against the EUR. That’s strange, as EUR has a negative interest rate.
Typically, a trade derived from Forex fundamental analysis doesn’t have a stop loss. Or, at least not a physical one.
Instead, traders tend to be ahead of the curve when using fundamental analysis. In comparison, any technical analysis including volume analysis Forex traders use has immediate effects.
The trading style dictates how a trader reacts to fundamental analysis. The regular economic news may not matter for the macroeconomic trader that considers Forex fundamental analysis on a big scale only.
Or, top-tier economic data won’t matter for the scalper either. There’s a habit for scalpers (mostly technical analysis traders) to avoid trading when major economic news comes out.
What’s certain is that both technical and fundamental factors influence levels in Forex trading. For example, support and resistance in confluence areas on bigger timeframes.
All traders will spot them, and the supply and demand imbalances will move prices.
To sum up, there’s no recipe for successful trading. One can use both technical analysis and fundamental one and fail. In that case, most likely the money management wasn’t at its best.
Other traders use only Forex technical analysis to trade. They build robots or expert advisors and program them to buy or sell a currency pair when certain conditions arise.
As such, they don’t care about any kind of economic news. Most of the times, they shut down the robot when essential events are due.
One thing is for sure: neither Forex fundamental analysis nor Forex technical analysis work without money management. Hence, the right Forex trading approach uses a bit from everything.