There are basically 2 primary methods that Forex traders use to analyze the market. They are technical and fundamental analysis. Pure technical analysts will say that it is impossible to trade on the news, because the market moves so fast and whatever news out there the charts will tell you too. On the other hand, fundamentalists will say that only the news moves the market. Technical indicators are always the followers. So which methods should we use? To find out, let’s look at the pros and cons of both of these methods.
Technical Analysis
Technical analysis involves tracking past currency price movements and use indicators to help identify in which direction the current price may be heading. This analysis can be performed manually or automatically. Under the automated system traders use software (expert advisor) or robot to help them find trades and identify entry and exit points. Technical traders believe that all of the required information needed to place a trade is contained in the charts.
Fundamental Analysis
Fundamental analysis focuses on key underlying economic, financial and political factors to determine the price direction of a currency. Fundamental traders believed that currencies movements, whether it becomes stronger or weaker, are related to the strength of the economy, financial and political situations. Hence, fundamental reports and news are important to them. News and reports such as interest rates, employment, trade balance and GDP are of great important. Others information such as retail sales, durable goods, home sales and ISM will also impact the price movement.
Technical Analysis
Advantages
-It helps provide specific entry and exit point for traders during trading.
-Charting can provide everyone an easy way of identifying trends immediately. This is possible because the same data is also being watched by millions of traders, as a result if a large number of Forex traders do the same, this will potentially create a self-fulfilling prophecy of reinforcing the trends further.
-It focuses on charts and indicators. It is without doubt the easiest and most precise method used by many traders so far.
-Charts and tools can also sometime help point out when a trend is about to start or end. Hence help traders to plan their profits and stop losses more accurately.
Disadvantages
-If many traders place their stops around the same areas, this could prompt a reverse in price movement as it can potentially allows bigger players in the market to intentionally trigger these stops.
-The tools used are basically lagging indicators. It can be dangerous to rely totally on the assumption that the current price and trend will predict future prices. They often do, but not necessarily.
-Relying completely on charts mean that you may not pick up other signals that may potentially change the trend.
Fundamental Analysis
Advantages
-Fundamental analysis increases our knowledge and understanding of the global market. Hence help us to get a clearer picture of the general health of the world economy.
-We can use fundamental analysis to explain some of the unexpected movement of the prices. Hence know what move the prices higher or lower.
-Major news release can sometime ignite large price movement when there is a big difference between expectations and actual results. If you can predict and capture this price movement, it can be very profitable.
-Fundament analysis is better used for forecasting longer term exchange rate movement.
Disadvantages
-There is so much information that one can easily be confused.
-It is very difficult to use all this information to pin point a specific entry or exit point to trade.
-Sometime short term news release may provide a false signal and mislead trader into opening a trade. This signal often develops a knee-jerk reaction in the market.
-Sometimes the information or news released may already have been priced into the market. Hence, the information has no significant impact to the price movement.
-It requires a person with at least some basic knowledge of economic background.
-News releases can sometime produce dramatic and fast price movement for a currency pair in both up and down directions as the Forex market try to digests the news. Inexperience traders may find themselves caught in a string of losses.
Conclusion
In my opinion, there is no ideal or best method of analyzing the Forex that will guarantee you a 100% results all the time. Technical analysis and charting will assist short-term traders to make their decisions, whereas long-term traders will need to keep themselves abreast of the latest economic news and data pertaining to the country currencies they are trading in. Note that these analysis methods are just tools. If used correctly, it can generally help you to trade more effectively. This is why most Forex traders tend to use both analysis approaches to make trading decision.
