Technical Analysis vs Fundamental Analysis
The debate between technical analysis and fundamental analysis as trading tools will likely go unanswered as both sides present remarkable arguments as to which one reigns supreme. This article will outline the basics of technical and fundamental analysis, leaving you with the knowledge to create your own trading journey.
What is Technical Analysis?
Technical analysis is the process by which financial market participants use market data, patterns, technical indicators, and trends to forecast market movements.
Some popular indicators include:
- The Simple Moving Average (SMA) indicator which aims to stabilize price data over a specified period of time to help traders identify potential trends and entry points.
- The Relative Strength Index or RSI is known as a momentum indicator and provides users with the current state (bias) of the asset. Additionally, the RSI offers potential market positioning and can be used to anticipate price reversals.
What is fundamental analysis?
Fundamental analysis gives priority to the economic and political environment determining the price of assets. In the area of foreign exchange, factors such as interest rate decisions and inflation are some of the major forces to consider, while commodity market fundamentals could include data on the ‘Offer and demand. Many of these data points are present on economic calendars and can be viewed through major financial sites.
When to use technical and fundamental analysis?
From personal experience, I use a combination of both techniques as I use fundamental analysis as my base, where I tend to start with an overview of the economic calendar relative to the asset class/currency pair. It is important to know when market events might occur in order to employ a sound risk management technique.
Depending on your trading time horizon, these economic events could be more or less significant. Price action encompasses fundamentals (past releases) in all cases, but upcoming events challenge traders in a different way. This is why a good understanding of the fundamentals can go a long way towards improving a trading strategy.
Moving on to technical analysis, there are an endless number of approaches and combinations one can use to trade and I have found that starting with a good foundation of technical tools helps every trader find their trading style. staff. My style incorporates a blend of price action and one or two indicators at most, but each trader will find what suits their style best over time.. My use of fundamentals first and technical analysis second is only one way of using both methods, however, many proponents of the respective systems have found success in a singular use. There’s no “one size fits all” or hard and fast rules about what to use when, but understanding the purpose and assumptions behind the methods you want to use is imperative.
How to trade with technical and fundamental analysis?
As mentioned above, trading as a single means of analysis or combination can work in practice, so I have included examples of all three approaches to demonstrate the versatility of the analysis procedure.
EXAMPLE OF TECHNICAL ANALYSIS
The chart above shows a modest but effective technical analysis setup using trendlines, an SMA and an RSI. Joining highs and lows using trendlines is a great way to gauge the overall market trend as well as possible stretched trade positioning (blue). It is often the first stopover in my technical analysis device after which I seek to insert my indicators.
The RSI is used to show any extreme bias in the market and is marked respectively by the green and red areas on the RSI (on the chart above). Finally, I included an SMA (50 and 100). The SMA is a versatile indicator that can help gauge or support the direction of the trend – if prices are above the SMA, a bullish bias is favored and vice versa. Additionally, SMA (yellow) crossovers can indicate an upcoming upward or downward movement – bullish when the short-term SMA (red) crosses above the longer-term SMA (black) with the same logic applied for the reverse. Key psychological levels and confluence zones play an important role in trader psychology, this has been eliminated from this example but should not be overlooked in real world application.
EXAMPLE OF FUNDAMENTAL ANALYSIS
One of the main drivers of foreign exchange prices comes from interest rates and their differentials. The monthly NZD/USD chart above shows the start of monetary policy easing by the RBNZ in April 2015 while the Fed began raising rates soon after. The result is a depreciation of the NZD against the dollar, as the lure of a higher interest rate attracts investors to US assets and foreign direct investment, thereby increasing demand for the USD. This simple example of interest rate dynamics shows the influence of economic theory in the forex market and how it can help traders gain a tactical advantage.
EXAMPLE OF TECHNICAL AND FUNDAMENTAL ANALYSIS
The last example and my personal preference uses both technical and fundamental analysis. This can arguably be the most complex of the three scenarios, but has proven to be effective in my experience. The Dollar Index (DXY) weekly chart above involves price action, trend lines, candlestick patterns, indicators and fundamental knowledge.
Starting with the Fed rate hike shown on the chart; prior to the actual announcement, markets had some momentum of an impending rate hike following past statements by Fed officials and money market prices – much of this information is freely available from major financial media and business education websites. Knowing this, the immediate tilt for DXY price action would be to the upside, but what’s the technical show?
The weekly candle at the time of the announcement was hovering around the key psychological handle at 95.00 with the support line of the bullish pennant (yellow) and the 50-day SMA. This is no coincidence as technical analysis reflects fundamental conditions! From here, a trader can wait for the weekly candle to close (blue), which provides an additional bullish signal via the lower long wick in this case.
My involvement in trading tells me that the more factors/signs in favor of a particular direction, the better the chances of a successful trade. If the trade is moving in the opposite direction, using price action data such as swing lows and highs can help place appropriate stops that are absent in the purely fundamental trade.
Technical Analysis vs Fundamental Analysis: Frequently Asked Questions (FAQ)
Advantages and disadvantages of technical and fundamental analysis
Is technical analysis more profitable than fundamental analysis?
Technical analysis and fundamental analysis have advantages and disadvantages, but neither can receive the title of the most profitable type of analysis. Many traders have been profitable in both specialties and will depend on traders goals, time horizon and risk appetite. There are many factors to consider when choosing a trading strategy and will differ from person to person, so testing trading strategies on demo accounts/platforms beforehand will greatly improve your process. trading when entering the real environment.