Fundamental vs. Technical Analysis
Fundamental analysis is the application of macro economics to interpret the “big picture” of an economy and as well as microeconomics to ascertain market conditions of a country. In the Forex, fundamental analysis of foreign exchange rates involves analyzing data and making judgments one country’s currency versus another to determine possible future value.
Typical questions a fundamental trader would ask are:
“What are interest rates?”
“What is the state of government affairs?”
“Is the country or region at war or peace?”
“Does the country have a large account deficit?”
“Is there political uncertainty?”
Besides key economic indicators such as Interest Rate announcements, Employment reports, and GDP, some of the key fundamentals affecting a currency pair are:
Asset Markets – A country’s equity markets, such as the stock market. The flow of funds into other financial assets of a country can increase the demand for that country’s currency. The net flow of funds into investment products influences the demand for a currency and causes it to be bought and sold.
Balance of Trade – A country’s balance between its: Exports vs. Imports, Foreign Spending vs. Foreign Aid, and Domestic vs. Foreign Investments. A currency will move as a result of a nation’s global trading position. Those countries that run a trade deficit generally have a decline in their currency. Those with a surplus, generally have appreciating currencies.
Political Environment– Overall national confidence, stability and certainty in a nation’s government.
Major news event – War, terrorism, catastrophic event, weather.
Expectations vs. Sentiment – Expectations are formed ahead of the release of economic data. Sentiment is the prevailing market attitude as a result of the overall economic assessment, general market conditions, or other factors.
Intervention – A tactic by a nation’s Central bank to counter undesirable exchange rate movements to ensure domestic economic growth and stability.
Technical analysis is the application of evaluating market activity by analyzing historical price performance as an indication of future performance. Technical traders use specific methods to identify potential market activity by means of trend recognition, pattern identification, and price ranges. Questions a technical trader asks are:
“Where is price now in comparison to where it was yesterday?”
“What is the major support and resistance levels?”
“Is price movement trending up or down?”
“Is price movement in a narrow trading range?”
“Where are the key price breakout levels?”
Some of the key components of technical analysis are:
Price – First and foremost, price is king of technical analysis. Knowing price variables such as Open, High, Low, Close is valuable information. Yet, understanding price action as the currency pair moves is equally as important. For instance, multiple new highs or new lows in a short term period could signal a break of a range.
Support – Often referred to as the support level, it is the price a currency pair trades but does not trade below over a period of time. Support is the price point at which the majority of the market believes that prices will trade higher thus causing an increase in demand as Long positions start to outnumber Short positions.
Resistance – Often referred to as the resistance level, it is the price a currency pair trades but does not trade higher over a period of time. Resistance is the price point at which the majority of the market believes that prices will trade lower thus causing decrease in demand as Short positions begin to outnumber Long positions.
Trend – In general, it is the current market direction based upon consistent change or movement in price. For instance, an upward trend is shown by successive higher prices while a downward trend is represented by consecutive lower prices over a period of time. A price break of a trend is sometimes considered a signal for the market to be in a reversal.
Channel – Also referred as a price range, it is often shown on a chart as price fluctuating between support and resistance levels over a period of time. The most common channel is sideways. But, a channel can be upward or downward.
Moving Average – one of the most popular tools in technical analysis is a calculation of the average price of the currency pair over a period of time. It is used to observe changes in price for potential trends and recognizable trade patterns. Typically, the shorter the time period the more volatile or choppy the moving average becomes. Whereas, the longer the time period, the smoother the moving average is.
DISCLAIMER: Trading futures, options on futures and off-exchange Foreign Exchange market (FX, Forex) is very speculative in nature, involves considerable risk and is not suitable for all investors. Before participating in trading, you should carefully consider your investment objectives, level of experience and risk appetite. Investors should only use risk capital when trading because there is always the risk of substantial loss. Most importantly, do not invest money you cannot afford to lose. Any mention of past performance is not indicative of future results. Account access, trade executions and system response may be adversely affected by market conditions, quote delays, system performance and other factors.
Past results as represented in testimonials are not necessarily indicative of future results or success. Testimonials may not be representative of all reasonably comparable students. Trading involves significant risk of loss and may not be suitable for all investors.
RISK WARNING: Trading futures and foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to trade foreign exchange you should carefully consider your monetary objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your deposited funds and therefore you should not speculate with capital that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent advisor if you have any doubts. Past returns are not indicative of future results.
Compass FX and its affiliates assume no responsibility for errors, inaccuracies or omissions in these materials. They do not warrant the accuracy or completeness of the information, text, graphics, links or other items contained within these materials. Compass FX and its affiliates shall not be liable for any special, indirect, incidental, or consequential damages, including without limitation losses, lost revenues, or lost profits that may result from these materials. This is not a solicitation to buy or sell currency or futures. Compass FX is compensated for its services through commissions and/or the spread between the bid/ask prices. All replies should be sent to email@example.com . Replies sent to firstname.lastname@example.org will be received by the Compass FX corporate email system and are subject to storage and review by someone other than the recipient.
HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM.
ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.