Technical vs fundamental analysis in the currency markets

Trading currencies can be done using technical analysis, fundamental analysis, or a combination of the two.

Technical analysis involves the study of past foreign currency exchange rates to determine what a currency is likely to do in the future. Even though it is impossible to predict what a currency will do in the future, a currency trader will increase his chances of being right if he applies technical analysis correctly.

Technical analysis is applied on a currency chart of a certain period depending on how frequently the currency trader is willing to buy and sell a currency. For example, a currency day trader may use a candlestick chart with a 30-minute period to generate his signals while a multiple-day position trader may use a 1 or 2-hour chart. The trader can then use various technical indicators in combination with the trend of the specific currency pair he is looking at to make a buy or sell decision.

One common mistake a currency trader makes in applying technical analysis is to forget the reason why technical analysis works and to rely on it blindly. Technical analysis works because many people use it. It is like a self-fulfilling prophesy. When people become overly dependent on technical analysis to trade, they might continuously change their trading style trying to find the elusive magical combination of technical indicators that work or a different trading system. Consequently, they fail to obtain the necessary trading experience that comes from practicing the same thing over and over.

Fundamental analysis in the currency market involves the use of different information and statistics to try to determine what the price of a currency "should" logically do. The fundamental currency trader will try to forecast the future price movements of a currency pair based on his analysis of the economy, political situation, and other factors and statistics of the relevant countries involved.

One big disadvantage in relying solely on what logically "should" happen to a currency exchange rate is that over confidence in the analysis could result in the justification of losses. As specified in the currency trading article, "Trading Currencies with a Strategy," losses must be limited in currency trading. If a fundamental analyst concludes that the price of a currency should rise versus another currency, then he might be tempted to let his losses accumulate if the price drops instead while he waits (or "hopes") for the price to go up. This is the reason why it is important for a currency trader to also use technical analysis even if he is mainly relying on fundamentals.

Many currency traders use a combination of technical analysis and fundamental analysis to trade currencies. There is also a large number that simply uses technical analysis to trade. Although some people are involved in trading currencies only using fundamental analysis, we do not recommend that our clients do the same.

In our free currency trading training, we will teach our customers how to use technical analysis to trade currencies.

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