Everything in the forex market is a tug of war.
We usually say that the market is moved by the struggle between the bulls (buyers) and bears (sellers). It is whoever emerges more powerful that takes the day and forms the trends.
Well, this is not the only fight that goes on in the financial trading industry.
The second war happens between fundamentalists and technical traders. These two sides have been fighting forever on which type of analysis is the best. The technical side claims that the charts have all the info that a trader needs to make their decisions.
On the other part, the fundamentalists say that the charts react to external factors, particularly the intrinsic value of the asset being traded.
Who do you think is right?
Today, we are going to look at both sides of this debate and see who is right. Is it the technical traders or fundamentalists?
Before we go deep into this topic, let me tell you a little story about myself and a friend of mine who also trades.
You see, I am a staunch technical trader. I believe that analyzing the charts is what makes sense to me as a trader.
My friend, Susan, is a fundamentalist.
She is ever looking at some weird graphs, analyzing economies and digging for company data to make her trading decisions.
The funny bit is that both of us are traders that have some small achievement.
While she scorns my MT4 charts and custom indicators that I use, I don’t mind because, at the end of the day, I make some good money.
On the other hand, when I look at her complex charts with tons of data, I understand nothing at all, so I look away. Similarly, she loves her method and it gives her enough money for her luxurious life.
Now, that said, let’s start the debate and see which side comes out stronger.
In case these terms are new to you, we are going to define them afresh.
Fundamental analysis involves the analysis of the external factors that affect the future demand and supply of an instrument. For instance, a fundamentalist who trades oil might follow world news keenly to find evidence on the future price of oil. They may perceive an ongoing war in any oil-producing nation as a potential factor to cause an increase in oil prices.
You might have also done some fundamental analysis when you follow Non-farm Payrolls or Interest Rate data to base your trading decisions.
Technical analysis, on its part, involves the observation of charts created by the movement of prices. Technical traders believe that the market is not random. Rather, they claim to see repetitive price behaviors and patterns that when accurately spotted, can be used to predict the future movement of the price.
If you have used support and resistance, Fibonacci, Moving Averages, candlestick patterns and so on to make your trading decisions, then you have done some technical analysis.
1.Sentiment is Clear
We all agree that supply and demand drive the market. One of the best things about technical analysis is that it gives clear information on the sentiment of supply and demand. When demand is high, the prices increase. When supply is high, the prices decrease.
In short, you only need to look at the market and then it becomes clear whether the buyers or sellers are in control. This is what we usually refer to as the trend. If you have more sellers, then you say the sentiment is bearish. As such, you know that you stand to be safer when selling than buying.
2. Definite Entry and Exit
The second advantage of technical charts is that they somehow tell us where to enter a trade, where to place the stop losses, and when to exit. This is especially true when looking at market swings (highs and lows), support and resistance, Moving Averages, Pivots, Fibonacci areas and so on.
In a nutshell, you don’t have to guess or rely on “invisible” data for entries and exits.
3. Repetitive Patterns
The major definitive aspect of technical analysis is that it contains patterns that repeat themselves over and over. Once a trader learns to spot them correctly, they can always lie in wait for the patterns to form then they take the appropriate trades.
Let’s say that you look for candlestick patterns. You will be sure that when a doji forms, there is indecision in the market. Similarly, candles formed with long wicks on a common zone will tell you that there is potential price reversal due to the observed rejection.
The last advantage of technical analysis is that it can be used to build confluence. This means that you can have multiple tools to analyze the market, then, when they all give you the same signal, then you take the trade.
In a more practical way, let’s say you use Moving Average crossovers, Fibonacci, RSI, and Bollinger Bands to trade. So, at some point, the Moving Averages cross and tell you to sell.
At the same time, the Fibonacci tool hits a resistance level and tells you to sell. Still, you have the RSI is an overbought zone, meaning that a sell trade is imminent. Then, finally, the Bollinger bands expand and tell you that selling volatility is increasing.
The above scenario means you have 4 tools telling you to sell. This is more convincing than just relying on one tool. As such, with the right combination of tools, you can have strong signals produced by the confluence of multiple tools.
1. Intrinsic Value is Ignored
Whether we accept it or not, the fundamental aspect of instruments influences prices to some extent. In fact, when sudden changes in the underlying value of an instrument occur, they disrupt even the best technical patterns.
For example, during the 9/11 attacks, the value of the dollar and most US stocks decreased sharply without warning. The result was a sudden movement of prices that ignored all technical aspects.
For the fundamentalist who keenly follows world news, they must have seen the breaking news and quickly closed their trades. As for the unlucky technical trader, they must have made losses.
2. Price is a lagging factor
The biggest drawback of technical analysis is that it is only able to show us what has already happened. If a candle closes in green, we know that for the past X period, the bulls were in control.
Therefore, at times, we get the trading signals when it is already too late. Taking late signals carries the risk of inaccurate analysis, thus, losses.
3. Short-term Prediction
Finally, you need to understand that chart patterns can only predict short-term movements.
Since the patterns already have definite shapes, the signals that they produce will also have expiry times. Practically, for instance, if you get a buy signal on a support level, you must exit the trade at the next resistance level.
The bad side of this type of trading is that it might limit one’s earning potential. In the above case, for instance, the price might get to the resistance level and bypass it (fail to respect it).
1. The Data is Accurate
The fact that fundamental analysis looks at the root value of an instrument and all the potentially influential factors means the resulting information is very accurate.
If we can put this in a better way, say, if Australia releases data that the volume of their exports grew, then we expect the Australian Dollar to increase in value. In this case, we buy the AUD.
Using this approach eliminates a lot of guesswork or assumptions. Personal bias is also eliminated since the available data only has one potential effect (buy or sell the instrument).
2. Long-term Prediction
When we have the important data of an instrument such as consumer trends, state of the economy, as well as economic and demographic standings, then we can tell the long-term future of the instrument being traded.
In short, fundamentalists can hold onto their trades for as long as the existing supportive conditions prevail.
3. Best for Investing
The above factor (long-term view) makes the fundamental analysis more of an investment strategy than it is trading.
Let’s say you received news that due to the completion of new goldmines construction in South Africa, gold would be worth five times more its current value in 2 years. What would you do? Personally, I would buy as much gold as possible and hold it for 2 years then sell it once it has grown in value.
4. Better Understanding of the Market
It is mandatory for a fundamentalist to have an all-round understanding of the instruments that they are trading. Possessing this crucial knowledge makes it easier to understand its behavior and future movement.
For example, I understand that the demand for oil (WTI) is highest during the winter and summer months. Therefore, if you trade this commodity, then you will stay in touch with the American calendar and wait for the perfect opportunity to buy it.
This is one example of possessing extra know-how about a trading instrument as opposed to making blind trades.
1. It is Tedious
Collecting all the data required for a complete fundamental assessment of a single instrument requires a lot of time. Each asset needs to be analyzed on all potential levels such as economic, demographic, underlying value, external factors and so on.
The process becomes tedious when the trader has several instruments to analyze. There is also the risk of information overload which might demotivate the trader or lead to inaccurate predictions.
2. Unclear Entry, Exit Points
The second shortfall of fundamental analysis is that there is some form of assumption regarding the entry, exit, stop loss and take profit points. This is because a trader only has the data and no visual reference points on the charts.
Better put, you may be told that the GBP will start gaining strength “soon”, but, without a method of knowing when the process begins, then some guesswork is involved. The same is true with placing the stop loss and take profit. There is some relief in exiting the trades since the trader can look out for when the opposite data emerges.
3. Fewer Opportunities
It has been proven that fundamentalists make fewer trades than technical traders. This statement is true in that fundamental traders must wait for specific data to be made available so they can find trading opportunities.
On the contrary, if a technical trader wants more trading opportunities, the can look for them on lower timeframes. Therefore, we can say that technical traders have more control over their trading than fundamentalists.
At this point, you’re going to assume the role of a judge and decide which between the two proves stronger and better.
I’m not sure if you will agree with me, but, I think it’s up to the trader as an individual to decide on which type of analysis works for them.
I have tried to do the deep fundamental analysis like my friend, but I have never succeeded. In the same way, she has tried to like my charts but she just cannot do it.
Let’s see some considerations that you can take when deciding which analysis is best for you:
i. Are you a day or swing trader?
From the discussion, we read that fundamental analysis takes longer to manifest itself. Conversely, technical analysis is suitable for the short-term trader. So, it is up to you to decide whether you want to hold your trades for weeks, or you want to sleep with all trades for the day closed.
ii. Do you want to trade or invest?
Second, we saw that due to the long-term nature of fundamental analysis, it is best-suited for investors. However, consider that investment requires more operating capital. A trader, on the other hand, prefers taking profits from the market regularly. Therefore, if you have to feed yourself and pay rent from trading, you might want to be a technical trader.
iii. What works for you?
The other very important factor that you ought to consider is what you feel is right for you. You might choose to go for either of these two without any hands-on experience only to later find out that it’s not working. In that case, you can try your hand on the other. Experimenting is a good way of finding out where your best skill lies.
Aha! You heard me right; use both!
Once you have settled on the best method for your analysis, try to learn a little bit of the other form of analysis.
Let’s assume you do fundamental analysis. You learn that the USD/JPY is about to go higher. Go to the charts and open a timeframe like H4 or D1. Use a simple method like spotting supply (resistance) and demand (support) zones, or Moving Average crossovers to identify high probability entry points.
Similarly, when you execute your trades, look at previous swing highs and high lows. These can be used to place your stop loss and take profit levels.
On the same note, let’s say you use technical analysis. You need to keep an eye for fundamental data that can influence the outcome of your trades.
For example, Interest Rate Decisions for major currencies affect many pairs. The same happens with Non-farm Payroll data, unemployment rates, and other significant economic data. This will help to minimize surprise market moves that might trigger your stops or affect your analysis.
In a nutshell, a little knowledge of each method will go a long way in improving your market analysis skills.
Just like many other traders before us, we have not been able to conclude on which between the two is better.
The war continues!
As a trader, you should take the time to decide on the best approach to execute your market analysis. You would be lying to yourself if you took any of the sides and ignored the other.
We have seen that while one method might work for you, it might fail to work for me. Therefore, you should be independent when picking your side. At the end of the day, our aim is to milk profits from the markets regardless of what approach we take.
So, are you a fundamentalist or technical trader?