Finance

The Pros and Cons of Using Technical and Fundamental Analysis

There are 2 primary methods that Forex traders use to analyse the market. They are technical and fundamental analyses.

Pure technical analysts will say that it is impossible to trade on the news because the market moves so fast, and whatever news is 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 followers. So which methods should we use? To find out, let us 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 think that the charts contain all of the information they need to make a trade.

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 currency movements, whether it becomes stronger or weaker, are related to the strength of the economy and 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 important. Other information such as retail sales, durable goods, home sales, and ISM will also impact the price movement.

Technical Analysis

Advantages

  1. It helps provide specific entry and exit point for traders during trading.
  2. Charting can provide everyone with 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.
  3. It focuses on charts and indicators. It is, without doubt, the easiest and most precise method used by many traders so far.
  4. Charts and tools can also sometimes 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

  1. Suppose many traders place their stops around the same areas. In that case, this could prompt a reverse in price movement as it can potentially allow more prominent players in the market to trigger these stops intentionally.
  2. The tools used are 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.
  3. Relying entirely on charts mean that you may not pick up other signals that may potentially change the trend.

Fundamental Analysis

Advantages

  1. The 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.
  2. We can use fundamental analysis to explain some of the unexpected movements of the prices. Hence know what moves the prices higher or lower.
  3. A major news release can sometimes ignite massive price movement when there is a big difference between expectations and actual results. It can be very profitable if you can predict and capture this price movement.
  4. Fundament analysis is better used for forecasting longer-term exchange rate movement.

Disadvantages

  1. There is so much information that one can easily be confused.
  2. Using all this information to pinpoint a specific entry or exit point to trade is complicated.
  3. Sometimes short-term news releases may provide a false signal and mislead traders into opening a trade. This signal often develops a knee-jerk reaction in the market.
  4. Sometimes the information or news released may already have been priced into the market. Hence, the information has no significant impact on the price movement.
  5. It requires a person with at least some basic economic background knowledge.
  6. News releases can sometimes produce dramatic and fast price movement for a currency pair in both up and down directions as the Forex market try to digest the news. Inexperienced traders may find themselves caught in a string of losses.

Conclusion

In my opinion, there is no ideal or best method of analysing Forex that will guarantee you 100% results all the time. Technical analysis and charting will assist short-term traders in making their decisions. In contrast, long-term traders will need to keep themselves abreast of the latest economic news and data about 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 use both analysis approaches to make a trading decision.

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