There is a great debate in the trading world regarding what is the best approach to trading: technical or fundamental analysis. Technical analysis refers to projecting future prices based on what patterns market formed back in time, while fundamental analysis means to project future prices based on the economic news to be released.
While each of the two types of analysis is important, it goes without saying that one should take into account both technical and fundamental analysis in order to succeed in trading the forex market. Technical analysis may give the direction and the target and stop loss for a trade, but fundamental analysis gives the reason for the move to come.
Trading a currency pair represents analyzing the two economies of the currencies that form the pair and taking a trading decision based on the outcome. In order to analyze an economy, one has to look at the economic calendar and see the relevant economic releases for those currencies. That is the moment when the currency pair will move.
The economic calendar contains economic events known in advance to be released at specific moments during the trading day, week and month and it is to be found for free on a simple Internet search. There are many websites that offer this calendar so finding one is quite easy.
The economic news is structured based on the importance and there is a color code to decipher; red represents very important news and market is expected to move aggressively with its release, orange represents second tier data while news that has little impact is shown with the yellow color.
Before the important news is to be released, market is usually consolidating and then a break comes based on the outcome.
An economic release is to be interpreted in the following way; there are three columns to watch, one with the previous data, one with the forecasted value for the current release, and one with the actual release.
For example, let’s assume that the Unemployment Rate in the United States is being released. It is a red event; extremely important; therefore market is expecting to move sharply on the release. If the actual comes lower than the forecasted number, then it should be positive for the US dollar as a lower unemployment rate is good for any economy. As a consequence, depending on the currency pair traded, the US dollar will be the cause of the direction the pair is heading.
A trader needs to be able to differentiate the important news, or the ones that really matter from the ones that are secondary, and a currency trader should take into account the following, in this order:
– Central banks interest rate decisions. When it comes to currency trading, there is no other economic release than the interest rate set by the central bank. If the central bank raises the rates, this is bullish for the currency, while lowering rates is perceived to be bearish. Depending on the economy that is analyzed, central banks have different periods during a year when they are meeting to set the interest rates. For example, in the United States, the Federal Reserve is meeting every six weeks to assess the state of the US economy and to set the appropriate interest rate and monetary policy.
– Consumer Price Index (CPI) or inflation. Each central bank has a mandate and this is to keep inflation below or close to 2%. Therefore, if inflation moves away from that target, the central bank will be forced to react at the next meeting, hence the currency will move aggressively. Inflation is released on a monthly or yearly basis, and it is closely watched by traders all over the world as it is the first educated guess one is having when it comes to anticipating the central bank’s next move.
– Jobs data. Jobs creation is vital for any economy and some central banks have a dual mandate, in the sense that they are moving on interest rates based on jobs creation as well. This makes this indicator extremely important and in the United States it is being called the NFP or Non-Farm Payrolls and it is released on the first Friday of each month.
– PMI’s or Purchasing Managers Index. These PMI’s are actually surveys based on different sectors of an economy and the result is compared with the 50 level. If the PMI for a specific sector, like services, is coming above the 50 level, it is considered that the sector is expanding, which is a good sign and traders will buy that specific currency on expectations that the central bank is going to see that too and will act on rates the next time it meets. The opposite is true as well, as a move below the 50 level shows contraction and recession and the proper response from the central bank will be to cut the rates or ease the monetary policy next time it meets.
I think that it is clear now why technical analysis should be used together with the fundamental one before taking a trading decision and ignoring one of the two is the biggest mistake a trader can make.