When it comes to analyzing the Forex market, there are two basic schools of thought.
One is called fundamental analysis, which is the study of a nation’s overall economy. Proponents of this big-picture view believe that price trends can be predicted by analyzing various economic indicators which give an overall picture of an economy’s health.
The other school of thought is called technical analysis. The core belief behind technical analysis is that prices tend to follow patterns, and that by analyzing past price patterns one can predict what the price will be in the future.
But which type is better?
Combine Fundamental and Technical Analysis
Well, to be honest neither. You need to combine both types of analysis to become a successful trader. Limiting yourself to only one or the other is a recipe for disaster.
Because by using only one method you’re only looking at half of the picture. Let me use an example to make my point.
Let’s say you’re a strict technical analyst and you have no use for fundamental analysis. “What do I need to look at economic indicators for,” you say. “I have my price charts and they shall never let me down!”
As you study your charts, you begin to see an opportunity forming. You’ve got 3 or 4 indicators showing that a huge breakout is about to occur. The US dollar is about to go on a rampage and rush to get in early. So you make the trade, sit back, put your feet, and wait for the price to soar.
But then something funny happens. The price drops 50 pips!
What the Heck Just Happened??
In disgust, you walk away from your computer and flip on the television just in time to see the financial report. It turns out that the latest Unemployment numbers were just released and the number is much higher than expected. At the same time, one of the world’s largest corporations announced that their earnings were well under forecasted amounts, and they predicted sales would continue to be sluggish through the next quarter.
Those two variables through a major monkey wrench in the price rally you predicted. If only you had mixed a little fundamental analysis in with all of those price charts you were busy studying you may have seen this one coming.
Of course, using fundamental analysis alone is not the solution. The big-picture view of fundamental analysis is great at identifying general trends in price movement, but it does not give a detailed enough look to provide entry and exit points. Sure you may know that the Swiss franc is due for a price increase, but how much? When should you buy and then when should you sell?
Only by incorporating both methods into your trading system do you have a chance to be a successful trader.